10-Q 1 y64172e10vq.htm FORM 10-Q 10-Q
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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
FORM 10-Q
     
(Mark One)
   
 
X
  QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the quarterly period ended June 27, 2008
OR
     
  
  TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the transition period from            to           
 
Commission file number 1-7182
 
MERRILL LYNCH & CO., INC.
(Exact name of Registrant as specified in its charter)
 
     
Delaware
  13-2740599
(State or Other Jurisdiction of
Incorporation or Organization)
  (I.R.S. Employer Identification No.)
     
4 World Financial Center,
New York, New York
 
10080
(Address of Principal Executive Offices)
  (Zip Code)
 
(212) 449-1000
Registrant’s telephone number, including area code:
 
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.
 
X     YES          NO
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
 
Large Accelerated Filer  X Accelerated Filer     Non-Accelerated Filer     Smaller Reporting Company    
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
 
      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.
 
1,528,978,506 shares of Common Stock and 2,484,974 Exchangeable Shares as of the close of business on August 1, 2008. The Exchangeable Shares, which were issued by Merrill Lynch & Co., Canada Ltd. in connection with the merger with Midland Walwyn Inc., are exchangeable at any time into Common Stock on a one-for-one basis and entitle holders to dividend, voting, and other rights equivalent to Common Stock.


 

 
MERRILL LYNCH & CO., INC. QUARTERLY REPORT ON FORM 10-Q
FOR THE QUARTERLY PERIOD ENDED JUNE 27, 2008
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 EX-12: Statement Re: Computation of Ratios
 EX-15: Letter of Awareness from Deloitte & Touche LLP
 EX-31.1: Certification
 EX-31.2: Certification
 EX-32.1: Certification
 EX-32.2: Certification
 EX-99.2: Pro Forma Stockholders' Equity


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Available Information
 
We file annual, quarterly and current reports, proxy statements and other information with the Securities and Exchange Commission (“SEC”). You may read and copy any document we file with the SEC at the SEC’s Public Reference Room at 100 F Street, NE, Room 1580, Washington, DC 20549. Please call the SEC at 1-800-SEC-0330 for information on the Public Reference Room. The SEC maintains an internet site that contains annual, quarterly and current reports, proxy and information statements and other information that we file electronically with the SEC. The SEC’s internet site is www.sec.gov.
 
Our internet address is www.ml.com, and the investor relations section of our website can be accessed directly at www.ir.ml.com. We make available, free of charge, our proxy statements, Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934. These reports are available through our website as soon as reasonably practicable after such reports are electronically filed with, or furnished to, the SEC. We have also posted on our website corporate governance materials including our Guidelines for Business Conduct, Code of Ethics for Financial Professionals, Director Independence Standards, Corporate Governance Guidelines, Related Party Transactions Policy and charters for the committees of our Board of Directors. In addition, our website (through a link to the SEC’s website) includes information on purchases and sales of our equity securities by our executive officers and directors, as well as disclosures relating to certain non-GAAP financial measures (as defined in the SEC’s Regulation G) that we may make public orally, telephonically, by webcast, by broadcast or by similar means from time to time.
 
We will post on our website amendments to our Guidelines for Business Conduct and Code of Ethics for Financial Professionals and any waivers that are required to be disclosed by the rules of either the SEC or the New York Stock Exchange. You can obtain printed copies of these documents, free of charge, upon written request to Judith A. Witterschein, Corporate Secretary, Merrill Lynch & Co., Inc., 222 Broadway, 17th Floor, New York, NY 10038 or by email at corporate ­ ­ secretary@ml.com. The information on our website is not incorporated by reference into this Report.


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PART I. FINANCIAL INFORMATION
 
ITEM 1. Financial Statements
 
Merrill Lynch & Co., Inc. and Subsidiaries
Condensed Consolidated Statements of (Loss)/Earnings (Unaudited)
 
                 
    For the Three Months Ended
    June 27,
  June 29,
(In millions, except per share amounts)   2008   2007
 
Revenues
               
Principal transactions
  $ (4,083 )   $ 3,556  
Commissions
    1,811       1,787  
Managed accounts and other fee-based revenues
    1,399       1,349  
Investment banking
    1,158       1,528  
Earnings from equity method investments
    111       375  
Other
    (1,875 )     387  
                 
      (1,479 )     8,982  
Interest and dividend revenues
    7,535       14,447  
Less interest expense
    8,172       13,970  
                 
Net interest (loss)/profit
    (637 )     477  
                 
Revenues, net of interest expense
    (2,116 )     9,459  
                 
Non-interest expenses
               
Compensation and benefits
    3,491       4,731  
Communications and technology
    566       482  
Brokerage, clearing, and exchange fees
    370       346  
Occupancy and related depreciation
    328       273  
Professional fees
    263       245  
Advertising and market development
    166       200  
Office supplies and postage
    55       56  
Other
    311       300  
Restructuring charge
    445       -  
                 
Total non-interest expenses
    5,995       6,633  
                 
Pre-tax (loss)/earnings from continuing operations
    (8,111 )     2,826  
Income tax (benefit)/expense
    (3,477 )     816  
                 
Net (loss)/earnings from continuing operations
    (4,634 )     2,010  
                 
Discontinued operations:
               
Pre-tax (loss)/earnings from discontinued operations
    (32 )     197  
Income tax (benefit)/expense
    (12 )     68  
                 
Net (loss)/earnings from discontinued operations
    (20 )     129  
                 
Net (loss)/earnings
  $ (4,654 )   $ 2,139  
                 
Preferred stock dividends
  $ 237     $ 72  
                 
Net (loss)/earnings applicable to common stockholders
  $ (4,891 )   $ 2,067  
                 
Basic (loss)/earnings per common share from continuing operations
  $ (4.95 )   $ 2.32  
Basic (loss)/earnings per common share from discontinued operations
    (0.02 )     0.16  
                 
Basic (loss)/earnings per common share
  $ (4.97 )   $ 2.48  
                 
Diluted (loss)/earnings per common share from continuing operations
  $ (4.95 )   $ 2.10  
Diluted (loss)/earnings per common share from discontinued operations
    (0.02 )     0.14  
                 
Diluted (loss)/earnings per common share
  $ (4.97 )   $ 2.24  
                 
Dividend paid per common share
  $ 0.35     $ 0.35  
                 
Average shares used in computing earnings per common share
               
Basic
    984.1       833.8  
Diluted
    984.1       923.3  
 
 See Notes to Condensed Consolidated Financial Statements


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Merrill Lynch & Co., Inc. and Subsidiaries
Condensed Consolidated Statements of (Loss)/Earnings (Unaudited)
 
                 
    For the Six Months Ended
    June 27,
  June 29,
(In millions, except per share amounts)   2008   2007
 
Revenues
               
Principal transactions
  $ (6,501 )   $ 6,290  
Commissions
    3,700       3,500  
Managed accounts and other fee-based revenues
    2,854       2,633  
Investment banking
    2,075       3,038  
Earnings from equity method investments
    542       684  
Other
    (3,324 )     1,228  
                 
      (654 )     17,373  
Interest and dividend revenues
    19,396       27,168  
Less interest expense
    17,924       25,479  
                 
Net interest profit
    1,472       1,689  
                 
Revenues, net of interest expense
    818       19,062  
                 
Non-interest expenses
               
Compensation and benefits
    7,687       9,585  
Communications and technology
    1,121       961  
Brokerage, clearing, and exchange fees
    757       656  
Occupancy and related depreciation
    637       538  
Professional fees
    505       471  
Advertising and market development
    342       355  
Office supplies and postage
    112       115  
Other
    624       654  
Restructuring charge
    445       -  
                 
Total non-interest expenses
    12,230       13,335  
                 
Pre-tax (loss)/earnings from continuing operations
    (11,412 )     5,727  
Income tax (benefit)/expense
    (4,809 )     1,687  
                 
Net (loss)/earnings from continuing operations
    (6,603 )     4,040  
                 
Discontinued operations:
               
Pre-tax (loss)/earnings from discontinued operations
    (57 )     391  
Income tax (benefit)/expense
    (44 )     134  
                 
Net (loss)/earnings from discontinued operations
    (13 )     257  
                 
Net (loss)/earnings
  $ (6,616 )   $ 4,297  
                 
Preferred stock dividends
  $ 411     $ 124  
                 
Net (loss)/earnings applicable to common stockholders
  $ (7,027 )   $ 4,173  
                 
Basic (loss)/earnings per common share from continuing operations
  $ (7.17 )   $ 4.67  
Basic (loss)/earnings per common share from discontinued operations
    (0.01 )     0.31  
                 
Basic (loss)/earnings per common share
  $ (7.18 )   $ 4.98  
                 
Diluted (loss)/earnings per common share from continuing operations
  $ (7.17 )   $ 4.22  
Diluted (loss)/earnings per common share from discontinued operations
    (0.01 )     0.28  
                 
Diluted (loss)/earnings per common share
  $ (7.18 )   $ 4.50  
                 
Dividend paid per common share
  $ 0.35     $ 0.35  
                 
Average shares used in computing earnings per common share
               
Basic
    978.5       837.6  
Diluted
    978.5       926.8  
 
 See Notes to Condensed Consolidated Financial Statements


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Merrill Lynch & Co., Inc. and Subsidiaries
Condensed Consolidated Balance Sheets (Unaudited)
 
                 
    June 27,
  Dec. 28,
(dollars in millions, except per share amounts)   2008   2007
 
ASSETS
               
                 
Cash and cash equivalents
  $ 31,211     $ 41,346  
                 
Cash and securities segregated for regulatory purposes or deposited with clearing organizations
    26,228       22,999  
                 
Securities financing transactions
               
Receivables under resale agreements (includes $105,047 in 2008 and $100,214 in 2007 measured at fair value in accordance with SFAS No. 159)
    224,958       221,617  
Receivables under securities borrowed transactions (includes $1,201 in 2008 measured at fair value in accordance with SFAS No. 159)
    129,426       133,140  
                 
      354,384       354,757  
Trading assets, at fair value (includes securities pledged as collateral that can be sold or repledged of $23,401 in 2008 and $45,177 in 2007)
               
Derivative contracts
    86,492       72,689  
Equities and convertible debentures
    42,870       60,681  
Corporate debt and preferred stock
    37,769       37,849  
Mortgages, mortgage-backed, and asset-backed
    29,273       28,013  
Non-U.S. governments and agencies
    8,825       15,082  
U.S. Government and agencies
    6,784       11,219  
Municipals, money markets and physical commodities
    5,626       9,136  
                 
      217,639       234,669  
                 
Investment securities (includes $4,556 in 2008 and $4,685 in 2007 measured at fair value in accordance with SFAS No. 159) (includes securities pledged as collateral that can be sold or repledged of $4,111 in 2008 and $16,124 in 2007)
    71,286       82,532  
                 
Securities received as collateral, at fair value
    51,505       45,245  
                 
Other receivables
               
Customers (net of allowance for doubtful accounts of $91 in 2008 and $24 in 2007)
    70,798       70,719  
Brokers and dealers
    17,300       22,643  
Interest and other
    32,684       33,487  
                 
      120,782       126,849  
                 
Loans, notes, and mortgages (net of allowances for loan losses of $602 in 2008 and $533 in 2007) (includes $1,204 in 2008 and $1,149 in 2007 measured at fair value in accordance with SFAS No. 159)
    79,170       94,992  
                 
Equipment and facilities (net of accumulated depreciation and amortization of $5,779 in 2008 and $5,518 in 2007)
    3,142       3,127  
                 
Goodwill and other intangible assets
    5,058       5,091  
                 
Other assets
    5,805       8,443  
                 
                 
Total Assets
  $ 966,210     $ 1,020,050  
                 


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Merrill Lynch & Co., Inc. and Subsidiaries
Condensed Consolidated Balance Sheets (Unaudited)
 
                 
    June 27,
  Dec. 28,
(dollars in millions, except per share amount)   2008   2007
 
LIABILITIES
               
                 
Securities financing transactions
               
Payables under repurchase agreements (includes $81,193 in 2008 and $89,733 in 2007 measured at fair value in accordance with SFAS No. 159)
  $ 197,881     $ 235,725  
Payables under securities loaned transactions
    65,691       55,906  
                 
      263,572       291,631  
                 
Short-term borrowings (includes $3,112 in 2008 measured at fair value in accordance with SFAS No. 159)
    19,139       24,914  
                 
Deposits
    100,458       103,987  
                 
Trading liabilities, at fair value
               
Derivative contracts
    65,908       73,294  
Equities and convertible debentures
    25,362       29,652  
Non-U.S. governments and agencies
    6,460       9,407  
U.S. Government and agencies
    4,541       6,135  
Corporate debt and preferred stock
    3,254       4,549  
Municipals, money markets and other
    451       551  
                 
      105,976       123,588  
                 
Obligation to return securities received as collateral, at fair value
    51,505       45,245  
                 
Other payables
               
Customers
    65,633       63,582  
Brokers and dealers
    15,743       24,499  
Interest and other
    33,777       44,545  
                 
      115,153       132,626  
                 
Long-term borrowings (includes $91,667 in 2008 and $76,334 in 2007 measured at fair value in accordance with SFAS No. 159)
    270,436       260,973  
                 
Junior subordinated notes (related to trust preferred securities)
    5,193       5,154  
                 
                 
Total Liabilities
    931,432       988,118  
                 
COMMITMENTS AND CONTINGENCIES
               
                 
STOCKHOLDERS’ EQUITY
               
                 
Preferred Stockholders’ Equity (liquidation preference of $30,000 per share; issued: 2008 — 244,100 shares; 2007 — 155,000 shares; liquidation preference of $1,000 per share; issued: 2008 and 2007 — 115,000 shares; liquidation preference of $100,000 per share; issued: 2008 — 66,000 shares)     13,666       4,383  
Common Stockholders’ Equity
               
Shares exchangeable into common stock
    39       39  
Common stock (par value $1.331/3 per share; authorized: 3,000,000,000 shares; issued: 2008 — 1,414,588,700 shares; 2007 — 1,354,309,819 shares)
    1,885       1,805  
Paid-in capital
    31,200       27,163  
Accumulated other comprehensive loss (net of tax)
    (3,685 )     (1,791 )
Retained earnings
    15,978       23,737  
                 
      45,417       50,953  
Less: Treasury stock, at cost (2008 — 431,518,432 shares; 2007 — 418,270,289 shares)
    24,305       23,404  
                 
Total Common Stockholders’ Equity
    21,112       27,549  
                 
                 
Total Stockholders’ Equity
    34,778       31,932  
                 
                 
Total Liabilities and Stockholders’ Equity
  $ 966,210     $ 1,020,050  
                 
 
 See Notes to Condensed Consolidated Financial Statements


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Merrill Lynch & Co., Inc. and Subsidiaries
Condensed Consolidated Statements of Cash Flows (Unaudited)
 
                 
    For the Six Months Ended
        June 29,
        2007
    June 27,
  As Restated
(dollars in millions)   2008   See Note 16
 
Cash flows from operating activities:
               
Net (loss)/earnings
  $ (6,616 )   $ 4,297  
Adjustments to reconcile net (loss)/earnings to cash used for operating activities
               
Depreciation and amortization
    452       306  
Share-based compensation expense
    1,357       885  
Deferred taxes
    (3,353 )     196  
Earnings from equity method investments
    (153 )     (540 )
Other
    3,787       752  
Changes in operating assets and liabilities:
               
Trading assets
    17,030       (21,091 )
Cash and securities segregated for regulatory purposes or deposited with clearing organizations
    (2,058 )     (4,835 )
Receivables under resale agreements
    (3,341 )     (82,896 )
Receivables under securities borrowed transactions
    3,714       (68,745 )
Customer receivables
    (78 )     (6,664 )
Brokers and dealers receivables
    5,345       (10,926 )
Proceeds from loans, notes, and mortgages held for sale
    15,010       45,073  
Other changes in loans, notes, and mortgages held for sale
    (3,535 )     (49,358 )
Trading liabilities
    (16,324 )     21,590  
Payables under repurchase agreements
    (37,844 )     84,192  
Payables under securities loaned transactions
    9,785       28,387  
Customer payables
    2,051       6,537  
Brokers and dealers payables
    (8,756 )     16,481  
Trading investment securities
    411       5,748  
Other, net
    (2,375 )     (2,629 )
                 
Cash used for operating activities
    (25,491 )     (33,240 )
                 
Cash flows from investing activities:
               
Proceeds from (payments for):
               
Maturities of available-for-sale securities
    4,243       7,818  
Sales of available-for-sale securities
    20,021       15,728  
Purchases of available-for-sale securities
    (22,104 )     (28,997 )
Proceeds from the sale of discontinued operations
    12,576       -  
Equipment and facilities, net
    (454 )     (50 )
Loans, notes, and mortgages held for investment
    (8,588 )     6,205  
Other investments
    1,818       (4,232 )
Acquisitions, net of cash
    -       (1,267 )
                 
Cash provided by (used for) investing activities
    7,512       (4,795 )
                 
Cash flows from financing activities:
               
Proceeds from (payments for):
               
Commercial paper and short-term borrowings
    (6,439 )     1,954  
Issuance and resale of long-term borrowings
    53,564       75,517  
Settlement and repurchases of long-term borrowings
    (46,053 )     (29,985 )
Deposits
    (3,529 )     (1,323 )
Derivative financing transactions
    452       (28 )
Issuance of common stock
    2,535       700  
Issuance of preferred stock, net
    9,283       1,479  
Common stock repurchases
    -       (3,800 )
Other common stock transactions
    (870 )     267  
Excess tax benefits related to share-based compensation
    37       649  
Dividends
    (1,136 )     (749 )
                 
Cash provided by financing activities
    7,844       44,681  
                 
(Decrease)/increase in cash and cash equivalents
    (10,135 )     6,646  
Cash and cash equivalents, beginning of period
    41,346       32,109  
                 
Cash and cash equivalents, end of period
  $ 31,211     $ 38,755  
                 
Supplemental Disclosure of Cash Flow Information:
               
Cash paid for:
               
Income taxes (net of refunds)
  $ 116     $ 890  
Interest
    18,235       24,860  
 
 See Notes to Condensed Consolidated Financial Statements


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    For the Three Months Ended   For the Six Months Ended
    June 27,
  June 29,
  June 27,
  June 29,
(dollars in millions)   2008   2007   2008   2007
 
Net (loss)/earnings
  $ (4,654 )   $ 2,139     $ (6,616 )   $ 4,297  
Other comprehensive income/(loss), net of tax:
                               
Foreign currency translation adjustment
    (40 )     60       (48 )     24  
Net unrealized gain/(loss) on investment securities available-for-sale
    462       (82 )     (1,814 )     (24 )
Net deferred loss on cash flow hedges
    (89 )     (23 )     (40 )     (27 )
Defined benefit pension and postretirement plans
    1       5       6       9  
                                 
Total other comprehensive income/(loss), net of tax
    334       (40 )     (1,896 )     (18 )
                                 
Comprehensive (loss)/income
  $ (4,320 )   $ 2,099     $ (8,512 )   $ 4,279  
                                 
 
 See Notes to Condensed Consolidated Financial Statements


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Merrill Lynch & Co., Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Unaudited)
June 27, 2008
 
 
For a complete discussion of Merrill Lynch’s accounting policies, refer to the Audited Consolidated Financial Statements included in our Annual Report on Form 10-K for the year-ended December 28, 2007 (“2007 Annual Report”).
 
Basis of Presentation
 
The Condensed Consolidated Financial Statements include the accounts of Merrill Lynch & Co., Inc. (“ML & Co.”) and subsidiaries (collectively, “Merrill Lynch” or the “Company”). The Condensed Consolidated Financial Statements are presented in accordance with U.S. Generally Accepted Accounting Principles, which include industry practices. Intercompany transactions and balances have been eliminated. The interim Condensed Consolidated Financial Statements for the three and six month periods are unaudited; however, in the opinion of Merrill Lynch management, all adjustments (consisting of normal recurring accruals) necessary for a fair presentation of the Condensed Consolidated Financial Statements have been included.
 
These unaudited Condensed Consolidated Financial Statements should be read in conjunction with the audited Consolidated Financial Statements included in the 2007 Annual Report. 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. Certain reclassifications have been made to the prior period financial statements to conform to the current period presentation.
 
Merrill Lynch offers a broad array of products and services to its diverse client base of individuals, small to mid-size businesses, employee benefit plans, corporations, financial institutions, and governments around the world. These products and services are offered from a number of locations globally. In some cases, the same or similar products and services may be offered to both individual and institutional clients, utilizing the same infrastructure. In other cases, a single infrastructure may be used to support multiple products and services offered to clients. When Merrill Lynch analyzes its profitability, it does not focus on the profitability of a single product or service. Instead, Merrill Lynch views the profitability of businesses offering an array of products and services to various types of clients. The profitability of the products and services offered to individuals, small to mid-size businesses, and employee benefit plans is analyzed separately from the profitability of products and services offered to corporations, financial institutions, and governments, regardless of whether there is commonality in products and services infrastructure. As such, Merrill Lynch does not separately disclose the costs associated with the products and services sold or general and administrative costs either in total or by product.
 
When determining the prices for products and services, Merrill Lynch considers multiple factors, including prices being offered in the market for similar products and services, the competitiveness of its pricing compared to competitors, the profitability of its businesses and its overall profitability, as well as the profitability, creditworthiness, and importance of the overall client relationships.
 
Shared expenses that are incurred to support products and services and infrastructures are allocated to the businesses based on various methodologies, which may include headcount, square footage, and certain other criteria. Similarly, certain revenues may be shared based upon agreed methodologies. When looking at the profitability of various businesses, Merrill Lynch considers all expenses incurred,


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including overhead and the costs of shared services, as all are considered integral to the operation of the businesses.
 
Discontinued Operations
 
On August 13, 2007, Merrill Lynch announced a strategic business relationship with AEGON, N.V. (“AEGON”) in the areas of insurance and investment products. As part of this relationship, Merrill Lynch sold Merrill Lynch Life Insurance Company and ML Life Insurance Company of New York (together “Merrill Lynch Insurance Group” or “MLIG”) to AEGON for $1.3 billion in the fourth quarter of 2007 and resulted in an after-tax gain of approximately $316 million. The gain along with the financial results of MLIG, have been reported within discontinued operations for all periods presented. Merrill Lynch previously reported the results of MLIG in the Global Wealth Management (“GWM”) business segment. Refer to Note 15 for additional information.
 
On December 24, 2007 Merrill Lynch announced that it had reached an agreement with GE Capital to sell Merrill Lynch Capital, a wholly-owned middle-market commercial finance business. The sale included substantially all of Merrill Lynch Capital’s operations, including its commercial real estate division. This transaction closed on February 4, 2008. Merrill Lynch has included results of Merrill Lynch Capital within discontinued operations for all periods presented. Merrill Lynch previously reported results of Merrill Lynch Capital in the Global Markets and Investment Banking (“GMI”) business segment. Refer to Note 15 for additional information.
 
Consolidation Accounting Policies
 
The Condensed Consolidated Financial Statements include the accounts of Merrill Lynch, whose subsidiaries are generally controlled through a majority voting interest. In certain cases, Merrill Lynch subsidiaries may also be consolidated based on a risks and rewards approach. Merrill Lynch does not consolidate those special purpose entities that meet the criteria of a qualified special purpose entity (“QSPE”).
 
Merrill Lynch determines whether it is required to consolidate an entity by first evaluating whether the entity qualifies as a voting rights entity (“VRE”), a variable interest entity (“VIE”), or a QSPE.
 
VREs are defined to include entities that have both equity at risk that is sufficient to fund future operations and have equity investors with decision making ability that absorb the majority of the expected losses and expected returns of the entity. In accordance with SFAS No. 94, Merrill Lynch generally consolidates those VREs where it holds a controlling financial interest. For investments in limited partnerships and certain limited liability corporations that Merrill Lynch does not control, Merrill Lynch applies Emerging Issues Task Force (“EITF”) Topic D-46, Accounting for Limited Partnership Investments, which requires use of the equity method of accounting for investors that have more than a minor influence, which is typically defined as an investment of greater than 3% of the outstanding equity in the entity. For more traditional corporate structures, in accordance with Accounting Principles Board Opinion No. 18, The Equity Method of Accounting for Investments in Common Stock, Merrill Lynch applies the equity method of accounting where it has significant influence over the investee. Significant influence can be evidenced by a significant ownership interest (which is generally defined as a voting interest of 20% to 50%), significant board of director representation, or other contracts and arrangements.
 
VIEs — Those entities that do not meet the VRE criteria are generally analyzed for consolidation as either VIEs or QSPEs. Merrill Lynch consolidates those VIEs in which it absorbs the majority of the variability in expected losses and/or the variability in expected returns of the entity as required by


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FIN 46R. Merrill Lynch relies on a qualitative and/or quantitative analysis, including an analysis of the design of the entity, to determine if it is the primary beneficiary of the VIE and therefore must consolidate the VIE. Merrill Lynch reassesses whether it is the primary beneficiary of a VIE upon the occurrence of a reconsideration event.
 
QSPEs — QSPEs are passive entities with significantly limited permitted activities. QSPEs are generally used as securitization vehicles and are limited in the type of assets they may hold, the derivatives that they can enter into and the level of discretion they may exercise through servicing activities. In accordance with SFAS No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishment of Liabilities (“SFAS No. 140”), and FIN 46R, Merrill Lynch does not consolidate QSPEs.
 
Securitization Activities
 
In the normal course of business, Merrill Lynch securitizes commercial and residential mortgage loans and home equity loans; municipal, government, and corporate bonds; and other types of financial assets. Merrill Lynch may retain interests in the securitized financial assets through holding tranches of the securitization. In accordance with SFAS No. 140, Merrill Lynch recognizes transfers of financial assets that relinquish control as sales to the extent of cash and any proceeds received. Control is considered to be relinquished when all of the following conditions have been met:
 
  •  The transferred assets have been legally isolated from the transferor even in bankruptcy or other receivership;
  •  The transferee has the right to pledge or exchange the assets it received, or if the entity is a QSPE the beneficial interest holders have the right to pledge or exchange their beneficial interests; and
  •  The transferor does not maintain effective control over the transferred assets (e.g. the ability to unilaterally cause the holder to return specific transferred assets).
 
Revenue Recognition
 
Principal transactions revenues include both realized and unrealized gains and losses on trading assets and trading liabilities, investment securities classified as trading investments and fair value changes associated with structured debt. These instruments are recorded at fair value. Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between marketplace participants. Gains and losses are recognized on a trade date basis.
 
Commissions revenues includes commissions, mutual fund distribution fees and contingent deferred sales charge revenue, which are all accrued as earned. Commissions revenues also includes mutual fund redemption fees, which are recognized at the time of redemption. Commissions revenues earned from certain customer equity transactions are recorded net of related brokerage, clearing and exchange fees.
 
Managed accounts and other fee-based revenues primarily consist of asset-priced portfolio service fees earned from the administration of separately managed accounts and other investment accounts for retail investors, annual account fees, and certain other account-related fees.
 
Investment banking revenues include underwriting revenues and fees for merger and acquisition advisory services, which are accrued when services for the transactions are substantially completed. Underwriting revenues are presented net of transaction-related expenses. Transaction-related expenses, primarily legal, travel and other costs directly associated with the transaction, are deferred and


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recognized in the same period as the related revenue from the investment banking transaction to match revenue recognition.
 
Earnings from equity method investments include Merrill Lynch’s pro rata share of income and losses associated with investments accounted for under the equity method.
 
Other revenues include gains/(losses) on investment securities, including certain available-for-sale securities, gains/(losses) on private equity investments that are held for capital appreciation and/or current income, and gains/(losses) on loans and other miscellaneous items.
 
Contractual interest and dividends received and paid on trading assets and trading liabilities, excluding derivatives, are recognized on an accrual basis as a component of interest and dividend revenues and interest expense. Interest and dividends on investment securities are recognized on an accrual basis as a component of interest and dividend revenues. Interest related to loans, notes, and mortgages, securities financing activities and certain short- and long-term borrowings are recorded on an accrual basis with related interest recorded as interest revenue or interest expense, as applicable. Contractual interest on structured notes is recorded as a component of interest expense.
 
Use of Estimates
 
In presenting the Condensed Consolidated Financial Statements, management makes estimates regarding:
 
  •  Valuations of assets and liabilities requiring fair value estimates;
  •  Determination of other-than-temporary impairments for available-for-sale investment securities;
  •  The outcome of litigation;
  •  Assumptions and cash flow projections used in determining whether VIEs should be consolidated and the determination of the qualifying status of QSPEs;
  •  The realization of deferred taxes and the recognition and measurement of uncertain tax positions;
  •  The carrying amount of goodwill and other intangible assets;
  •  The amortization period of intangible assets with definite lives;
  •  Incentive-based compensation accruals and valuation of share-based payment compensation arrangements; and
  •  Other matters that affect the reported amounts and disclosure of contingencies in the financial statements.
 
Estimates, by their nature, are based on judgment and available information. Therefore, actual results could differ from those estimates and could have a material impact on the Condensed Consolidated Financial Statements, and it is possible that such changes could occur in the near term. A discussion of certain areas in which estimates are a significant component of the amounts reported in the Condensed Consolidated Financial Statements follows:
 
Fair Value Measurement
 
Merrill Lynch accounts for a significant portion of its financial instruments at fair value or considers fair value in their measurement. Merrill Lynch accounts for certain financial assets and liabilities at fair value under various accounting literature, including SFAS No. 115, Accounting for Certain Investments in Debt and Equity Securities (“SFAS No. 115”), SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities (“SFAS No. 133”), and SFAS No. 159, Fair Value Option for Certain Financial Assets and Liabilities (“SFAS No. 159”). Merrill Lynch also accounts for certain


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assets at fair value under applicable industry guidance, namely broker-dealer and investment company accounting guidance.
 
Merrill Lynch early adopted the provisions of SFAS No. 157, Fair Value Measurements (“SFAS No. 157”), in the first quarter of 2007. SFAS No. 157 defines fair value, establishes a framework for measuring fair value, establishes a fair value hierarchy based on the quality of inputs used to measure fair value and enhances disclosure requirements for fair value measurements. SFAS No. 157 nullifies the guidance provided by EITF Issue No. 02-3, Issues Involved in Accounting for Derivative Contracts Held for Trading Purposes and Contracts Involved in Energy Trading and Risk Management Activities (“EITF 02-3”), which prohibited recognition of day one gains or losses on derivative transactions where model inputs that significantly impact valuation are not observable.
 
Fair values for over-the-counter (“OTC”) derivative financial instruments, principally forwards, options, and swaps, represent the present value of amounts estimated to be received from or paid to a marketplace participant in settlement of these instruments (i.e., the amount Merrill Lynch would expect to receive in a derivative asset assignment or would expect to pay to have a derivative liability assumed). These derivatives are valued using pricing models based on the net present value of estimated future cash flows and directly observed prices from exchange-traded derivatives, other OTC trades, or external pricing services, while taking into account the counterparty’s creditworthiness, or Merrill Lynch’s own creditworthiness, as appropriate. Determining the fair value for OTC derivative contracts can require a significant level of estimation and management judgment.
 
New and/or complex instruments may have immature or limited markets. As a result, the pricing models used for valuation often incorporate significant estimates and assumptions that market participants would use in pricing the instrument, which may impact the results of operations reported in the Condensed Consolidated Financial Statements. For instance, on long-dated and illiquid contracts extrapolation methods are applied to observed market data in order to estimate inputs and assumptions that are not directly observable. This enables Merrill Lynch to mark to fair value all positions consistently when only a subset of prices are directly observable. Values for OTC derivatives are verified using observed information about the costs of hedging the risk and other trades in the market. As the markets for these products develop, Merrill Lynch continually refines its pricing models to correlate more closely to the market price of these instruments.
 
Prior to adoption of SFAS No. 157, Merrill Lynch followed the provisions of EITF 02-3. Under EITF 02-3, recognition of day one gains and losses on derivative transactions where model inputs that significantly impact valuation are not observable were prohibited. Day one gains and losses deferred at inception under EITF 02-3 were recognized at the earlier of when the valuation of such derivative became observable or at the termination of the contract. SFAS No. 157 nullifies this guidance in EITF 02-3. Although this guidance in EITF 02-3 has been nullified, the recognition of significant inception gains and losses that incorporate unobservable inputs are reviewed by management to ensure such gains and losses are derived from observable inputs and/or incorporate reasonable assumptions about the unobservable component, such as implied bid-offer adjustments.
 
Certain financial instruments recorded at fair value are initially measured using mid-market prices which results in gross long and short positions marked-to-market at the same pricing level prior to the application of position netting. The resulting net positions are then adjusted to fair value representing the exit price as defined in SFAS No. 157. The significant adjustments include liquidity and counterparty credit risk.


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Liquidity
 
Merrill Lynch makes adjustments to bring a position from a mid-market to a bid or offer price, depending upon the net open position. Merrill Lynch values net long positions at bid prices and net short positions at offer prices. These adjustments are based upon either observable or implied bid-offer prices.
 
Counterparty Credit Risk
 
In determining fair value Merrill Lynch considers both the credit risk of its counterparties, as well as its own creditworthiness. Credit risk to third parties is generally mitigated by entering into netting and collateral arrangements. Net exposure is then valued for counterparty creditworthiness and the resultant value is incorporated into the fair value of the respective instruments. The calculation of the credit adjustment for derivatives is generally based upon observable market credit spreads.
 
SFAS No. 157 requires that Merrill Lynch’s own creditworthiness be considered when determining the fair value of an instrument. The approach to measuring the impact of Merrill Lynch’s own credit on an instrument is the same approach as that used to measure third party credit risk.
 
Legal Reserves
 
Merrill Lynch is a party in various actions, some of which involve claims for substantial amounts. Amounts are accrued for the financial resolution of claims that have either been asserted or are deemed probable of assertion if, in the opinion of management, it is both probable that a liability has been incurred and the amount of the loss can be reasonably estimated. In many cases, it is not possible to determine whether a liability has been incurred or to estimate the ultimate or minimum amount of that liability until the case is close to resolution, in which case no accrual is made until that time. Accruals are subject to significant estimation by management with input from outside counsel.
 
Income Taxes
 
Merrill Lynch provides for income taxes on all transactions that have been recognized in the Condensed Consolidated Financial Statements in accordance with SFAS No. 109, Accounting for Income Taxes (“SFAS No. 109”). Accordingly, deferred taxes are adjusted to reflect the tax rates at which future taxable amounts will likely be settled or realized. The effects of tax rate changes on future deferred tax liabilities and deferred tax assets, as well as other changes in income tax laws, are recognized in net earnings in the period during which such changes are enacted. Valuation allowances are established when necessary to reduce deferred tax assets to the amounts expected to be realized. Merrill Lynch assesses its ability to realize deferred tax assets primarily based on the earnings history and other factors of the legal entities through which the deferred tax assets will be realized as discussed in SFAS No. 109. See Note 13 for further discussion of income taxes.
 
Merrill Lynch recognizes and measures its unrecognized tax benefits in accordance with FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes (“FIN 48”). Merrill Lynch estimates the likelihood, based on their technical merits, that tax positions will be sustained upon examination based on the facts and circumstances and information available at the end of each period. Merrill Lynch adjusts the level of unrecognized tax benefits when there is more information available, or when an event occurs requiring a change. The reassessment of unrecognized tax benefits could have a material impact on Merrill Lynch’s effective tax rate in the period in which it occurs.


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ML & Co. and certain of its wholly-owned subsidiaries file a consolidated U.S. federal income tax return. Certain other Merrill Lynch entities file tax returns in their local jurisdictions.
 
Securities Financing Transactions
 
Merrill Lynch enters into repurchase and resale agreements and securities borrowed and loaned transactions to accommodate customers and earn interest rate spreads (also referred to as “matched-book transactions”), obtain securities for settlement and finance inventory positions.
 
Resale and repurchase agreements are accounted for as collateralized financing transactions and may be recorded at their contractual amounts plus accrued interest or at fair value under the fair value option election in SFAS No. 159. Resale and repurchase agreements recorded at fair value are generally valued based on pricing models that use inputs with observable levels of price transparency.
 
Changes in the fair value of resale and repurchase agreements are reflected in principal transactions revenues and the contractual interest coupon is recorded as interest revenue or interest expense, respectively. For further information refer to Note 3. Resale and repurchase agreements recorded at their contractual amounts plus accrued interest approximate fair value, as the fair value of these items is not materially sensitive to shifts in market interest rates because of the short-term nature of these instruments or to credit risk because the resale and repurchase agreements are fully collateralized.
 
Merrill Lynch’s policy is to obtain possession of collateral with a market value equal to or in excess of the principal amount loaned under resale agreements. To ensure that the market value of the underlying collateral remains sufficient, collateral is generally valued daily and Merrill Lynch may require counterparties to deposit additional collateral or may return collateral pledged when appropriate.
 
Substantially all repurchase and resale activities are transacted under master netting agreements that give Merrill Lynch the right, in the event of default, to liquidate collateral held and to offset receivables and payables with the same counterparty. Merrill Lynch offsets certain repurchase and resale agreement balances with the same counterparty on the Condensed Consolidated Balance Sheets.
 
Merrill Lynch may use securities received as collateral for resale agreements to satisfy regulatory requirements such as Rule 15c3-3 of the SEC.
 
Securities borrowed and loaned transactions are recorded at the amount of cash collateral advanced or received. Securities borrowed transactions require Merrill Lynch to provide the counterparty with collateral in the form of cash, letters of credit, or other securities. Merrill Lynch receives collateral in the form of cash or other securities for securities loaned transactions. For these transactions, the fees received or paid by Merrill Lynch are recorded as interest revenue or expense. On a daily basis, Merrill Lynch monitors the market value of securities borrowed or loaned against the collateral value, and Merrill Lynch may require counterparties to deposit additional collateral or may return collateral pledged, when appropriate. The carrying value of these instruments approximates fair value as these items are not materially sensitive to shifts in market interest rates because of their short-term nature and/or their variable interest rates.
 
All firm-owned securities pledged to counterparties where the counterparty has the right, by contract or custom, to sell or repledge the securities are disclosed parenthetically in trading assets or, if applicable, in investment securities on the Condensed Consolidated Balance Sheets.
 
In transactions where Merrill Lynch acts as the lender in a securities lending agreement and receives securities that can be pledged or sold as collateral, it recognizes an asset on the Condensed Consolidated Balance Sheets carried at fair value, representing the securities received (securities


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received as collateral), and a liability for the same amount, representing the obligation to return those securities (obligation to return securities received as collateral). The amounts on the Condensed Consolidated Balance Sheets result from non-cash transactions.
 
Trading Assets and Liabilities
 
Merrill Lynch’s trading activities consist primarily of securities brokerage and trading; derivatives dealing and brokerage; commodities trading and futures brokerage; and securities financing transactions. Trading assets and trading liabilities consist of cash instruments (e.g., securities and loans) and derivative instruments used for trading purposes or for managing risk exposures in other trading inventory. See the Derivatives section for additional information on the accounting policy for derivatives. Trading assets and trading liabilities also include commodities inventory.
 
Trading assets and liabilities are generally recorded on a trade date basis at fair value. Included in trading liabilities are securities that Merrill Lynch has sold but did not own and will therefore be obligated to purchase at a future date (“short sales”). Commodities inventory is recorded at the lower of cost or market value. Changes in fair value of trading assets and liabilities (i.e., unrealized gains and losses) are recognized as principal transactions revenues in the current period. Realized gains and losses and any related interest amounts are included in principal transactions revenues and interest revenues and expenses, depending on the nature of the instrument.
 
Derivatives
 
A derivative is an instrument whose value is derived from an underlying instrument or index, such as interest rates, equity securities, currencies, commodities or credit spreads. Derivatives include futures, forwards, swaps, option contracts and other financial instruments with similar characteristics. Derivative contracts often involve future commitments to exchange interest payment streams or currencies based on a notional or contractual amount (e.g., interest rate swaps or currency forwards) or to purchase or sell other financial instruments at specified terms on a specified date (e.g., options to buy or sell securities or currencies). Derivative activity is subject to Merrill Lynch’s overall risk management policies and procedures.
 
SFAS No. 133, as amended, establishes accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts (“embedded derivatives”) and for hedging activities. SFAS No. 133 requires that an entity recognize all derivatives as either assets or liabilities in the Condensed Consolidated Balance Sheets and measure those instruments at fair value. The fair value of all derivatives is recorded on a net-by-counterparty basis on the Condensed Consolidated Balance Sheets where management believes a legal right of setoff exists under an enforceable netting agreement.
 
The accounting for changes in fair value of a derivative instrument depends on its intended use and if it is designated and qualifies as an accounting hedging instrument under SFAS No. 133.
 
Merrill Lynch enters into derivatives to facilitate client transactions, for proprietary trading and financing purposes, and to manage risk exposures arising from trading assets and liabilities. Derivatives entered into for these purposes are recognized at fair value on the Condensed Consolidated Balance Sheets as trading assets and liabilities, and changes in fair value are reported in current period earnings as principal transactions revenues.


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Merrill Lynch also enters into derivatives in order to manage risk exposures arising from assets and liabilities not carried at fair value as follows:
 
1.  Merrill Lynch routinely issues debt in a variety of maturities and currencies to achieve the lowest cost financing possible. In addition, Merrill Lynch’s regulated bank entities accept time deposits of varying rates and maturities. Merrill Lynch enters into derivative transactions to hedge these liabilities. Derivatives used most frequently include swap agreements that:
 
  •  Convert fixed-rate interest payments into variable-rate interest payments;
  •  Change the underlying interest rate basis or reset frequency; and
  •  Change the settlement currency of a debt instrument.
 
2.  Merrill Lynch enters into hedges on marketable investment securities to manage the interest rate risk, currency risk, and net duration of its investment portfolios.
 
3.  Merrill Lynch has fair value hedges of long-term fixed rate resale and repurchase agreements to manage the interest rate risk of these assets and liabilities. Subsequent to the adoption of SFAS No. 159, Merrill Lynch elects to account for these instruments on a fair value basis rather than apply hedge accounting.
 
4.  Merrill Lynch uses foreign-exchange forward contracts, foreign-exchange options, currency swaps, and foreign-currency-denominated debt to hedge its net investments in foreign operations. These derivatives and cash instruments are used to mitigate the impact of changes in exchange rates.
 
5.  Merrill Lynch enters into futures, swaps, options and forward contracts to manage the price risk of certain commodity inventory.
 
Derivatives entered into by Merrill Lynch to hedge its funding, marketable investment securities and net investments in foreign subsidiaries are reported at fair value in other assets or interest and other payables on the Condensed Consolidated Balance Sheets. Derivatives used to hedge commodity inventory are included in trading assets and trading liabilities on the Condensed Consolidated Balance Sheets.
 
Derivatives that qualify as accounting hedges under the guidance in SFAS No. 133 are designated as one of the following:
 
1.  A hedge of the fair value of a recognized asset or liability (“fair value” hedge). Changes in the fair value of derivatives that are designated and qualify as fair value hedges of interest rate risk, along with the gain or loss on the hedged asset or liability that is attributable to the hedged risk, are recorded in current period earnings as interest revenue or expense. Changes in the fair value of derivatives that are designated and qualify as fair value hedges of commodity price risk, along with the gain or loss on the hedged asset or liability that is attributable to the hedged risk, are recorded in current period earnings in principal transactions.
 
2.  A hedge of the variability of cash flows to be received or paid related to a recognized asset or liability (“cash flow” hedge). Changes in the fair value of derivatives that are designated and qualify as effective cash flow hedges are recorded in accumulated other comprehensive loss until earnings are affected by the variability of cash flows of the hedged asset or liability (e.g., when periodic interest accruals on a variable-rate asset or liability are recorded in earnings).
 
3.  A hedge of a net investment in a foreign operation. Changes in the fair value of derivatives that are designated and qualify as hedges of a net investment in a foreign operation are recorded in the foreign currency translation adjustment account within accumulated other comprehensive loss.


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  Changes in the fair value of the hedge instruments that are associated with the difference between the spot translation rate and the forward translation rate are recorded in current period earnings in other revenues.
 
Merrill Lynch formally assesses, both at the inception of the hedge and on an ongoing basis, whether the hedging derivatives are highly effective in offsetting changes in fair value or cash flows of hedged items. When it is determined that a derivative is not highly effective as a hedge, Merrill Lynch discontinues hedge accounting. Under the provisions of SFAS No. 133, 100% hedge effectiveness is assumed for those derivatives whose terms meet the conditions of SFAS No. 133 “short-cut method.”
 
As noted above, Merrill Lynch enters into fair value and cash flow hedges of interest rate exposure associated with certain investment securities and debt issuances. Merrill Lynch uses interest rate swaps to hedge this exposure. Hedge effectiveness testing is required for certain of these hedging relationships on a quarterly basis. For fair value hedges, Merrill Lynch assesses effectiveness on a prospective basis by comparing the expected change in the price of the hedge instrument to the expected change in the value of the hedged item under various interest rate shock scenarios. For cash flow hedges, Merrill Lynch assesses effectiveness on a prospective basis by comparing the present value of the projected cash flows on the variable leg of the hedge instrument against the present value of the projected cash flows of the hedged item (the “change in variable cash flows” method) under various interest rate, prepayment and credit shock scenarios. In addition, Merrill Lynch assesses effectiveness on a retrospective basis using the dollar-offset ratio approach. When assessing hedge effectiveness, there are no attributes of the derivatives used to hedge the fair value exposure that are excluded from the assessment. Ineffectiveness associated with these hedges was immaterial for all periods presented.
 
Merrill Lynch also enters into fair value hedges of commodity price risk associated with certain commodity inventory. For these hedges, Merrill Lynch assesses effectiveness on a prospective and retrospective basis using regression techniques. The difference between the spot rate and the contracted forward rate which represents the time value of money is excluded from the assessment of hedge effectiveness and is recorded in principal transactions revenues. The amount of ineffectiveness related to these hedges reported in earnings was not material for all periods presented.
 
Netting of Derivative Contracts
 
Where Merrill Lynch has entered into a legally enforceable netting agreement with counterparties, it reports derivative assets and liabilities, and any related cash collateral, net in the Condensed Consolidated Balance Sheets in accordance with FIN No. 39, Offsetting Amounts Related to Certain Contracts (“FIN No. 39”). Derivative assets and liabilities are presented net of cash collateral of approximately $25.0 billion and $49.3 billion, respectively, at June 27, 2008 and $13.5 billion and $39.7 billion, respectively, at December 28, 2007.
 
Derivatives that Contain a Significant Financing Element
 
In the ordinary course of trading activities, Merrill Lynch enters into certain transactions that are documented as derivatives where a significant cash investment is made by one party. Certain derivative instruments that contain a significant financing element at inception and where Merrill Lynch is deemed to be the borrower are included in financing activities in the Condensed Consolidated Statements of Cash Flows. The cash flows from all other derivative transactions that do not contain a significant financing element at inception are included in operating activities.


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Investment Securities
 
Investment securities consist of marketable investment securities and non-qualifying investments. Refer to Note 5 for further information.
 
Marketable Investments
 
ML & Co. and certain of its non-broker-dealer subsidiaries, including Merrill Lynch banks, follow the guidance in SFAS No. 115 when accounting for investments in debt and publicly traded equity securities. Merrill Lynch classifies those debt securities that it has the intent and ability to hold to maturity as held-to-maturity securities. Held-to-maturity securities are carried at cost unless a decline in value is deemed other-than-temporary, in which case the carrying value is reduced. For Merrill Lynch, the trading classification under SFAS No. 115 generally includes those securities that are bought and held principally for the purpose of selling them in the near term, securities that are economically hedged, or securities that may contain a bifurcatable embedded derivative as defined in SFAS No. 133. Securities classified as trading are marked to fair value through earnings. All other qualifying securities are classified as available-for-sale and held at fair value with unrealized gains and losses reported in accumulated other comprehensive loss. Any unrealized losses that are deemed other-than-temporary are included in current period earnings and removed from accumulated other comprehensive loss.
 
Realized gains and losses on investment securities are included in current period earnings. For purposes of computing realized gains and losses, the cost basis of each investment sold is generally based on the average cost method.
 
Merrill Lynch regularly (at least quarterly) evaluates each available-for-sale security whose value has declined below amortized cost to assess whether the decline in fair value is other-than-temporary. A decline in a debt security’s fair value is considered to be other-than-temporary if it is probable that not all amounts contractually due will be collected or management determines that it does not have the intent and ability to hold the security for a period of time sufficient for a forecasted market price recovery up to or beyond the amortized cost of the security.
 
Merrill Lynch’s impairment review generally includes:
 
•  Identifying securities with indicators of possible impairment;
•  Analyzing individual securities with fair value less than amortized cost for specific factors including:
  •  An adverse change in cash flows
  •  The estimated length of time to recover from fair value to amortized cost
  •  The severity and duration of the fair value decline from amortized cost
  •  Evaluating the financial condition of the issuer;
•  Discussing evidential matter, including an evaluation of the factors that could cause individual securities to qualify as having other-than-temporary impairment;
•  Determining whether management intends to hold the security through to recovery. To the extent that Merrill Lynch has the ability and intent to hold the securities, no impairment charge will be recognized; and
•  Documenting the analysis and conclusions.


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Non-Qualifying Investments
 
Non-qualifying investments are those investments that are not within the scope of SFAS No. 115 and primarily include private equity investments accounted for at fair value and securities carried at cost or under the equity method of accounting.
 
Private equity investments that are held for capital appreciation and/or current income are accounted for under the AICPA Accounting and Auditing Guide, Investment Companies (the “Investment Company Guide”) and carried at fair value. Additionally, certain private equity investments that are not accounted for under the Investment Company Guide may be carried at fair value under the fair value option election in SFAS No. 159. The carrying value of private equity investments reflects expected exit values based upon market prices or other valuation methodologies including expected cash flows and market comparables of similar companies.
 
Merrill Lynch has minority investments in the common shares of corporations and in partnerships that do not fall within the scope of SFAS No. 115 or the Investment Company Guide. Merrill Lynch accounts for these investments using either the cost or the equity method of accounting based on management’s ability to influence the investees (See Consolidation Accounting Policies section for more information).
 
For investments accounted for using the equity method, income is recognized based on Merrill Lynch’s share of the earnings or losses of the investee. Dividend distributions are generally recorded as reductions in the investment balance. Impairment testing is based on the guidance provided in APB Opinion No. 18, The Equity Method of Accounting for Investments in Common Stock, and the investment is reduced when an impairment is deemed other-than-temporary.
 
For investments accounted for at cost, income is recognized as dividends are received. Impairment testing is based on the guidance provided in FASB Staff Position Nos. SFAS 115-1 and SFAS 124-1, The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments, and the cost basis is reduced when an impairment is deemed other-than-temporary.
 
Loans, Notes, and Mortgages, Net
 
Merrill Lynch’s lending and related activities include loan originations, syndications, and securitizations. Loan originations include corporate and institutional loans, residential and commercial mortgages, asset-based loans, and other loans to individuals and businesses. Merrill Lynch also engages in secondary market loan trading (see Trading Assets and Liabilities section) and margin lending. Loans included in loans, notes, and mortgages are classified for accounting purposes as loans held for investment and loans held for sale.
 
Loans held for investment are carried at amortized cost, less an allowance for loan losses. The provision for loan losses is based on management’s estimate of the amount necessary to maintain the allowance for loan losses at a level adequate to absorb probable incurred loan losses and is included in interest revenue in the Condensed Consolidated Statements of (Loss)/Earnings. Management’s estimate of loan losses is influenced by many factors, including adverse situations that may affect the borrower’s ability to repay, current economic conditions, prior loan loss experience, and the estimated fair value of any underlying collateral. The fair value of collateral is generally determined by third-party appraisals in the case of residential mortgages, quoted market prices for securities, or other types of estimates for other assets.
 
Management’s estimate of loan losses includes judgment about collectibility based on available information at the balance sheet date, and the uncertainties inherent in those underlying assumptions.


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While management has based its estimates on the best information available, future adjustments to the allowance for loan losses may be necessary as a result of changes in the economic environment or variances between actual results and the original assumptions.
 
In general, loans are evaluated for impairment when they are greater than 90 days past due or exhibit credit quality weakness. Loans are considered impaired when it is probable that Merrill Lynch will not be able to collect the contractual principal and interest due from the borrower. All payments received on impaired loans are applied to principal until the principal balance has been reduced to a level where collection of the remaining recorded investment is not in doubt. Typically, when collection of principal on an impaired loan is not in doubt, contractual interest will be credited to interest income when received.
 
Loans held for sale are carried at lower of cost or fair value. The fair value option in SFAS No. 159 has been elected for certain held for sale loans, notes and mortgages. Estimation is required in determining these fair values. The fair value of loans made in connection with commercial lending activity, consisting mainly of senior debt, is primarily estimated using the market value of publicly issued debt instruments or discounted cash flows. Merrill Lynch’s estimate of fair value for other loans, notes, and mortgages is determined based on the individual loan characteristics. For certain homogeneous categories of loans, including residential mortgages, automobile loans, and home equity loans, fair value is estimated using a whole loan valuation or an “as-if” securitized price based on market conditions. An “as-if” securitized price is based on estimated performance of the underlying asset pool collateral, rating agency credit structure assumptions and market pricing for similar securitizations previously executed. Declines in the carrying value of loans held for sale and loans accounted for at fair value under the fair value option are included in other revenues in the Condensed Consolidated Statements of (Loss)/Earnings.
 
Nonrefundable loan origination fees, loan commitment fees, and “draw down” fees received in conjunction with held for investment loans are generally deferred and recognized over the contractual life of the loan as an adjustment to the yield. If, at the outset, or any time during the term of the loan, it becomes probable that the repayment period will be extended, the amortization is recalculated using the expected remaining life of the loan. When the loan contract does not provide for a specific maturity date, management’s best estimate of the repayment period is used. At repayment of the loan, any unrecognized deferred fee is immediately recognized in earnings. If the loan is accounted for as held for sale, the fees received are deferred and recognized as part of the gain or loss on sale in other revenues. If the loan is accounted for under the fair value option, the fees are included in the determination of the fair value and included in other revenue.
 
New Accounting Pronouncements
 
In June 2008, the FASB issued FSP EITF 03-6-1, Determining Whether Instruments Granted in Share-Based Payment Transactions Are Participating Securities (“FSP EITF 03-6-1”), which addresses whether instruments granted in share-based payment transactions are participating securities prior to vesting and, therefore, need to be included in the computation of earnings per share under the two-class method described in SFAS No. 128, Earnings per Share. FSP EITF 03-6-1, which will apply to Merrill Lynch because it grants instruments to employees in share-based payment transactions that meet the definition of participating securities, is effective retrospectively for financial statements issued for fiscal years and interim periods beginning after December 15, 2008. Merrill Lynch is currently evaluating the impact of FSP EITF 03-6-1 on the Condensed Consolidated Financial Statements.
 
In May 2008, the FASB issued FSP APB 14-1, Accounting for Convertible Debt Instruments That May Be Settled in Cash upon Conversion (Including Partial Cash Settlement) (“FSP APB 14-1”), which clarifies that convertible instruments that may be settled in cash upon conversion (including partial


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cash settlement) are not addressed by APB Opinion No. 14, Accounting for Convertible Debt and Debt Issued with Stock Purchase Warrants. Additionally, FSP APB 14-1 specifies that issuers of such instruments should separately account for the liability and equity components in a manner that will reflect the entity’s nonconvertible debt borrowing rate when interest cost is recognized in subsequent periods. FSP APB 14-1 which will apply to Merrill Lynch due to the issuance of contingently convertible liquid yield option notes (“LYONs”) is effective for financial statements issued for fiscal years and interim periods beginning after December 15, 2008, and is to be applied retrospectively for all periods that are presented in the annual financial statements for the period of adoption. Merrill Lynch is currently evaluating the impact of FSP APB 14-1 on the Condensed Consolidated Financial Statements.
 
In March 2008, the FASB issued SFAS No. 161, Disclosure about Derivative Instruments and Hedging Activities, an Amendment of FASB Statement No. 133 (“SFAS No. 161”). SFAS No. 161 is intended to improve transparency in financial reporting by requiring enhanced disclosures of an entity’s derivative instruments and hedging activities and their effects on the entity’s financial position, financial performance, and cash flows. SFAS No. 161 applies to all derivative instruments within the scope of SFAS No. 133. It also applies to non-derivative hedging instruments and all hedged items designated and qualifying as hedges under SFAS No. 133. SFAS No. 161 amends the current qualitative and quantitative disclosure requirements for derivative instruments and hedging activities set forth in SFAS No. 133 and generally increases the level of disaggregation that will be required in an entity’s financial statements. SFAS No. 161 requires qualitative disclosures about objectives and strategies for using derivatives, quantitative disclosures about fair value amounts of gains and losses on derivative instruments, and disclosures about credit-risk related contingent features in derivative agreements. SFAS No. 161 is effective prospectively for financial statements issued for fiscal years and interim periods beginning after November 15, 2008.
 
In February 2008, the FASB issued FSP FAS 140-3, Accounting for Transfers of Financial Assets and Repurchase Financing Transactions. Under the guidance in FSP FAS 140-3, there is a presumption that the initial transfer of a financial asset and subsequent repurchase financing involving the same asset are considered part of the same arrangement (i.e. a linked transaction) under SFAS No. 140. However, if certain criteria are met, the initial transfer and repurchase financing will be evaluated as two separate transactions under SFAS No. 140. FSP FAS 140-3 is effective for new transactions entered into in fiscal years beginning after November 15, 2008. Early adoption is prohibited. Merrill Lynch is currently evaluating the impact of FSP FAS 140-3 on the Condensed Consolidated Financial Statements.
 
In December 2007, the FASB issued SFAS No. 160, Noncontrolling Interests in Consolidated Financial Statements-an amendment of ARB No. 51 (“SFAS No. 160”). SFAS No. 160 requires noncontrolling interests in subsidiaries (formerly known as “minority interests”) initially to be measured at fair value and classified as a separate component of equity. Under SFAS No. 160, gains or losses on sales of noncontrolling interests in subsidiaries are not recognized, instead sales of noncontrolling interests are accounted for as equity transactions. However, in a sale of a subsidiary’s shares that results in the deconsolidation of the subsidiary, a gain or loss is recognized for the difference between the proceeds of that sale and the carrying amount of the interest sold and a new fair value basis is established for any remaining ownership interest. SFAS No. 160 is effective for Merrill Lynch beginning in 2009; earlier application is prohibited. SFAS No. 160 is required to be adopted prospectively, with the exception of certain presentation and disclosure requirements (e.g., reclassifying noncontrolling interests to appear in equity), which are required to be adopted retrospectively. Merrill Lynch is currently evaluating the impact of SFAS No. 160 on the Condensed Consolidated Financial Statements.


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In December 2007, the FASB issued SFAS No. 141R, Business Combinations (“SFAS No. 141R”), which significantly changes the financial accounting and reporting for business combinations. SFAS No. 141R will require:
 
•  More assets and liabilities to be measured at fair value as of the acquisition date,
•  Liabilities related to contingent consideration to be remeasured at fair value in each subsequent reporting period with changes reflected in earnings and not goodwill, and
•  All acquisition-related costs to be expensed as incurred by the acquirer.
 
SFAS No. 141R is required to be adopted on a prospective basis concurrently with SFAS No. 160 and is effective for business combinations beginning in fiscal 2009. Early adoption is prohibited. Merrill Lynch is currently evaluating the impact of SFAS No. 141R on the Condensed Consolidated Financial Statements.
 
In June 2007, the Accounting Standards Executive Committee of the AICPA issued Statement of Position 07-1, Clarification of the Scope of the Audit and Accounting Guide Investment Companies and Accounting by Parent Companies and Equity Method Investors for Investments in Investment Companies (“SOP 07-1”). The intent of SOP 07-1 is to clarify which entities are within the scope of the AICPA Audit and Accounting Guide, Investment Companies (the “Guide”). For those entities that are investment companies under SOP 07-1, the SOP also addresses whether the specialized industry accounting principles of the Guide (referred to as “investment company accounting”) should be retained by the parent company in consolidation or by an investor that accounts for the investment under the equity method because it has significant influence over the investee. On October 17, 2007, the FASB proposed an indefinite delay of the effective dates of SOP 07-1 to allow the Board to address certain implementation issues that have arisen and possibly revise SOP 07-1.
 
In April 2007, the FASB issued FSP No. FIN 39-1, Amendment of FASB Interpretation No. 39 (“FSP FIN 39-1”). FSP FIN 39-1 modifies FIN No. 39 and permits companies to offset cash collateral receivables or payables with net derivative positions. FSP FIN 39-1 is effective for fiscal years beginning after November 15, 2007 with early adoption permitted. Merrill Lynch adopted FSP FIN 39-1 in the first quarter of 2008. FSP FIN 39-1 did not have a material effect on the Condensed Consolidated Financial Statements as it clarified the acceptability of existing market practice, which Merrill Lynch applied, for netting of cash collateral against net derivative assets and liabilities.
 
In February 2007, the FASB issued SFAS No. 159, which provides a fair value option election that allows companies to irrevocably elect fair value as the initial and subsequent measurement attribute for certain financial assets and liabilities. Changes in fair value for assets and liabilities for which the election is made will be recognized in earnings as they occur. SFAS No. 159 permits the fair value option election on an instrument-by-instrument basis at initial recognition of an asset or liability or upon an event that gives rise to a new basis of accounting for that instrument. SFAS No. 159 is effective as of the beginning of an entity’s first fiscal year that begins after November 15, 2007. Early adoption is permitted. Merrill Lynch early adopted SFAS No. 159 in the first quarter of 2007. In connection with this adoption management reviewed its treasury liquidity portfolio and determined that Merrill Lynch should decrease its economic exposure to interest rate risk by eliminating long-term fixed rate assets from the portfolio and replacing them with floating rate assets. The fixed rate assets had been classified as available-for-sale and the unrealized losses related to such assets had been recorded in accumulated other comprehensive loss. As a result of the adoption of SFAS No. 159, the loss related to these assets was removed from accumulated other comprehensive loss and a loss of approximately $185 million, net of tax, primarily related to these assets, was recorded as a cumulative-effect adjustment to beginning retained earnings, with no material impact to total stockholders’ equity. Refer to Note 3 to the 2007 Annual Report for additional information.


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In September 2006, the FASB issued SFAS No. 157. SFAS No. 157 defines fair value, establishes a framework for measuring fair value, establishes a fair value hierarchy based on the quality of inputs used to measure fair value and enhances disclosure about fair value measurements. SFAS No. 157 nullifies the guidance provided by EITF 02-3 that prohibits recognition of day one gains or losses on derivative transactions where model inputs that significantly impact valuation are not observable. In addition, SFAS No. 157 prohibits the use of block discounts for large positions of unrestricted financial instruments that trade in an active market and requires an issuer to incorporate changes in its own credit spreads when determining the fair value of its liabilities. SFAS No. 157 is effective for fiscal years beginning after November 15, 2007 with early adoption permitted provided that the entity has not yet issued financial statements for that fiscal year, including any interim periods. The provisions of SFAS No. 157 are to be applied prospectively, except that the provisions related to block discounts and existing derivative financial instruments measured under EITF 02-3 are to be applied as a one-time cumulative effect adjustment to opening retained earnings in the year of adoption. Merrill Lynch early adopted SFAS No. 157 in the first quarter of 2007. The cumulative-effect adjustment to beginning retained earnings was an increase of approximately $53 million, net of tax, primarily representing the difference between the carrying amounts and fair value of derivative contracts valued using the guidance in EITF 02-3. The impact of adopting SFAS No. 157 was not material to the Condensed Consolidated Statement of (Loss)/Earnings. Refer to Note 3 to the 2007 Annual Report for additional information.
 
In September 2006, the FASB issued SFAS No. 158, Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans, an amendment of FASB Statements No. 87, 88, 106 and 132R (“SFAS No. 158”). SFAS No. 158 requires an employer to recognize the overfunded or underfunded status of its defined benefit pension and other postretirement plans, measured as the difference between the fair value of plan assets and the benefit obligation as an asset or liability in its statement of financial condition. Upon adoption, SFAS No. 158 requires an entity to recognize previously unrecognized actuarial gains and losses and prior service costs within accumulated other comprehensive loss, net of tax. In accordance with the guidance in SFAS No. 158, Merrill Lynch adopted this provision of the standard for year-end 2006. The adoption of SFAS No. 158 resulted in a net credit of $65 million to accumulated other comprehensive loss recorded on the Consolidated Financial Statements at December 29, 2006. SFAS No. 158 also requires defined benefit plan assets and benefit obligations to be measured as of the date of the company’s fiscal year-end. Merrill Lynch has historically used a September 30 measurement date. As of the beginning of fiscal year 2008, Merrill Lynch changed its measurement date to coincide with its fiscal year end. The impact of adopting the measurement date provision of SFAS No. 158 was not material to the Condensed Consolidated Financial Statements.
 
In June 2006, the FASB issued FIN 48. FIN 48 clarifies the accounting for uncertainty in income taxes recognized in a company’s financial statements and prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. FIN 48 also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure and transition. Merrill Lynch adopted FIN 48 in the first quarter of 2007. The impact of the adoption of FIN 48 resulted in a decrease to beginning retained earnings and an increase to the liability for unrecognized tax benefits of approximately $66 million. See Note 14 to the 2007 Annual Report for further information.
 
In March 2006, the FASB issued SFAS No. 156, Accounting for Servicing of Financial Assets (“SFAS No. 156”). SFAS No. 156 amends SFAS No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities, to require all separately recognized servicing assets and servicing liabilities to be initially measured at fair value, if practicable. SFAS No. 156 also permits servicers to subsequently measure each separate class of servicing assets and liabilities at fair value rather than at the lower of amortized cost or market. For those companies that elect to measure their servicing assets and liabilities at fair value, SFAS No. 156 requires the difference between the carrying


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value and fair value at the date of adoption to be recognized as a cumulative-effect adjustment to retained earnings as of the beginning of the fiscal year in which the election is made. Prior to adoption of SFAS No. 156 Merrill Lynch accounted for servicing assets and servicing liabilities at the lower of amortized cost or market. Merrill Lynch adopted SFAS No. 156 on December 30, 2006. Merrill Lynch has not elected to subsequently fair value those mortgage servicing rights (“MSR”) held as of the date of adoption or those MSRs acquired or retained after December 30, 2006. The adoption of SFAS No. 156 did not have a material impact on the Condensed Consolidated Financial Statements.
 
In February 2006, the FASB issued SFAS No. 155, Accounting for Certain Hybrid Financial Instruments an amendment of FASB Statements No. 133 and 140 (“SFAS No. 155”). SFAS No. 155 clarifies the bifurcation requirements for certain financial instruments and permits hybrid financial instruments that contain a bifurcatable embedded derivative to be accounted for as a single financial instrument at fair value with changes in fair value recognized in earnings. This election is permitted on an instrument-by-instrument basis for all hybrid financial instruments held, obtained, or issued as of the adoption date. At adoption, any difference between the total carrying amount of the individual components of the existing bifurcated hybrid financial instruments and the fair value of the combined hybrid financial instruments is recognized as a cumulative-effect adjustment to beginning retained earnings. Merrill Lynch adopted SFAS No. 155 on a prospective basis beginning in the first quarter of 2007. Since SFAS No. 159 incorporates accounting and disclosure requirements that are similar to SFAS No. 155, Merrill Lynch applies SFAS No. 159, rather than SFAS No. 155, to its fair value elections for hybrid financial instruments.
 
 
Segment Information
 
Merrill Lynch’s operations are organized into two business segments: Global Markets and Investment Banking (“GMI”) and Global Wealth Management (“GWM”). GMI provides full service global markets and origination products and services to corporate, institutional, and government clients around the world. GWM creates and distributes investment products and services for individuals, small- to mid-size businesses, and employee benefit plans.
 
Merrill Lynch also records revenues and expenses within a “Corporate” category. Corporate results primarily include the impact of junior subordinated notes (related to trust preferred securities), gains and losses related to ineffective interest rate hedges on certain qualifying debt, and the impact of certain hybrid financing instruments accounted for under SFAS No. 159. Net revenues and pre-tax losses recorded within Corporate for the second quarter of 2008 were negative $156 million as compared with negative net revenues and pre-tax losses of $79 million and $90 million, respectively, in the prior year period.
 
Net revenues and pre-tax losses recorded within Corporate for the six months ended June 27, 2008 were negative $131 million and $130 million, as compared with negative net revenues of $169 million and pre-tax losses of $180 million in the prior year period.
 
The following segment results represent the information that is relied upon by management in its decision-making processes. Management believes that the following information by business segment


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provides a reasonable representation of each segment’s contribution to Merrill Lynch’s consolidated net revenues and pre-tax earnings or loss from continuing operations.
 
                                 
(dollars in millions)
 
    GMI   GWM   Corporate   Total
     
 
Three Months Ended June 27, 2008
                               
Non-interest revenues
  $ (3,822 )   $ 2,749     $ (406 )   $ (1,479 )
Net interest (loss)/profit(1)
    (1,497 )     610       250       (637 )
                                 
Revenues, net of interest expense
    (5,319 )     3,359       (156 )     (2,116 )
Non-interest expenses(2)
    3,240       2,755       -       5,995  
                                 
Pre-tax (loss)/earnings from continuing operations(3)
  $ (8,559 )   $ 604     $ (156 )   $ (8,111 )
                                 
Quarter-end total assets
  $ 869,312     $ 96,472     $ 426     $ 966,210  
                                 
 
 
Three Months Ended June 29, 2007
                               
Non-interest revenues
  $ 6,066     $ 2,977     $ (61 )   $ 8,982  
Net interest (loss)/profit(1)
    (82 )     577       (18 )     477  
                                 
Revenues, net of interest expense
    5,984       3,554       (79 )     9,459  
Non-interest expenses
    4,047       2,575       11       6,633  
                                 
Pre-tax earnings/(loss) from continuing operations(3)
  $ 1,937     $ 979     $ (90 )   $ 2,826  
                                 
Quarter-end total assets(4)
  $ 983,246     $ 92,651     $ 427     $ 1,076,324  
                                 
 
 
Six Months Ended June 27, 2008
                               
Non-interest revenues
  $ (5,515 )   $ 5,709     $ (848 )   $ (654 )
Net interest (loss)/profit(1)
    (494 )     1,249       717       1,472  
                                 
Revenues, net of interest expense
    (6,009 )     6,958       (131 )     818  
Non-interest expenses(2)
    6,597       5,634       (1 )     12,230  
                                 
Pre-tax (loss)/earnings from continuing operations(3)
  $ (12,606 )   $ 1,324     $ (130 )   $ (11,412 )
                                 
 
 
Six Months Ended June 29, 2007
                               
Non-interest revenues
  $ 11,722     $ 5,715     $ (64 )   $ 17,373  
Net interest (loss)/profit(1)
    621       1,173       (105 )     1,689  
                                 
Revenues, net of interest expense
    12,343       6,888       (169 )     19,062  
Non-interest expenses
    8,199       5,125       11       13,335  
                                 
Pre-tax earnings/(loss) from continuing operations(3)
  $ 4,144     $ 1,763     $ (180 )   $ 5,727  
                                 
 
 
(1) Management views interest and dividend income net of interest expense in evaluating results.
(2) Includes restructuring charges recorded in the second quarter of 2008 of $311 million and $134 million for GMI and GWM, respectively. See Note 17 for further information.
(3) See Note 15 to the Condensed Consolidated Financial Statements for further information on discontinued operations.
(4) Amounts have been restated to reflect goodwill balances in the respective business segments. Such amounts ($3,350 million in GMI and $294 million in GWM) were previously included in Corporate.
 
Geographic Information
 
Merrill Lynch conducts its business activities through offices in the following five regions:
 
  •  United States;
  •  Europe, Middle East, and Africa;
  •  Pacific Rim;
  •  Latin America; and
  •  Canada.


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The principal methodologies used in preparing the geographic information below are as follows:
 
  •  Revenues and expenses are generally recorded based on the location of the employee generating the revenue or incurring the expense without regard to legal entity;
  •  Pre-tax earnings or loss from continuing operations include the allocation of certain shared expenses among regions; and
  •  Intercompany transfers are based primarily on service agreements.
 
The information that follows, in management’s judgment, provides a reasonable representation of each region’s contribution to the consolidated net revenues and pre-tax loss or earnings from continuing operations:
 
                                 
(dollars in millions)
 
    For the Three Months Ended   For the Six Months Ended
     
    June 27, 2008   June 29, 2007   June 27, 2008   June 29, 2007
 
 
Revenues, net of interest expense
                               
Europe, Middle East, and Africa
  $ 1,420     $ 2,120     $ 2,405     $ 4,223  
Pacific Rim
    729       1,493       1,546       2,680  
Latin America
    402       363       867       750  
Canada
    79       120       135       292  
                                 
Total Non-U.S.
    2,630       4,096       4,953       7,945  
United States(1)(2)
    (4,746 )     5,363       (4,135 )     11,117  
                                 
Total revenues, net of interest expense
  $ (2,116 )   $ 9,459     $ 818     $ 19,062  
                                 
Pre-tax (loss)/earnings from continuing operations
                               
Europe, Middle East, and Africa
  $ 197     $ 703     $ (164 )   $ 1,479  
Pacific Rim
    150       766       330       1,286  
Latin America
    201       162       369       358  
Canada
    30       62       28       176  
                                 
Total Non-U.S.
    578       1,693       563       3,299  
United States(1)(2)
    (8,689 )     1,133       (11,975 )     2,428  
                                 
Total pre-tax (loss)/earnings from continuing operations(3)
  $ (8,111 )   $ 2,826     $ (11,412 )   $ 5,727  
                                 
 
 
(1) Corporate net revenues and adjustments are reflected in the U.S. region.
(2) U.S. net revenues for the three and six months ended June 27, 2008 include net losses of $9.5 billion and $15.9 billion, respectively, related to U.S. ABS CDOs, credit valuation adjustments related to hedges with financial guarantors, losses in the investment portfolio of Merrill Lynch’s U.S. banks and other residential mortgage exposures. Losses for the six months ended June 27, 2008 were partially offset by gains of $2.2 billion that resulted from the widening of Merrill Lynch’s credit spreads on the carrying value of certain of our long-term debt liabilities.
(3) See Note 15 for further information on discontinued operations.
 
 
Fair Value Measurements
 
Fair Value Hierarchy
 
In accordance with SFAS No. 157, Merrill Lynch has categorized its financial instruments, based on the priority of the inputs to the valuation technique, into a three-level fair value hierarchy. The fair value hierarchy gives the highest priority to quoted prices in active markets for identical assets or liabilities (Level 1) and the lowest priority to unobservable inputs (Level 3). If the inputs used to


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measure the financial instruments fall within different levels of the hierarchy, the categorization is based on the lowest level input that is significant to the fair value measurement of the instrument.
 
Financial assets and liabilities recorded on the Condensed Consolidated Balance Sheets are categorized based on the inputs to the valuation techniques as follows:
 
Level 1.   Financial assets and liabilities whose values are based on unadjusted quoted prices for identical assets or liabilities in an active market that Merrill Lynch has the ability to access (examples include active exchange-traded equity securities, exchange-traded derivatives, most U.S. Government and agency securities, and certain other sovereign government obligations).
 
Level 2.   Financial assets and liabilities whose values are based on quoted prices in markets that are not active or model inputs that are observable either directly or indirectly for substantially the full term of the asset or liability. Level 2 inputs include the following:
 
  a)  Quoted prices for similar assets or liabilities in active markets (for example, restricted stock);
 
  b)  Quoted prices for identical or similar assets or liabilities in non-active markets (examples include corporate and municipal bonds, which trade infrequently);
 
  c)  Pricing models whose inputs are observable for substantially the full term of the asset or liability (examples include most over-the-counter derivatives, including interest rate and currency swaps); and
 
  d)  Pricing models whose inputs are derived principally from or corroborated by observable market data through correlation or other means for substantially the full term of the asset or liability (examples include certain residential and commercial mortgage-related assets, including loans, securities and derivatives).
 
Level 3.   Financial assets and liabilities whose values are based on prices or valuation techniques that require inputs that are both unobservable and significant to the overall fair value measurement. These inputs reflect management’s own assumptions about the assumptions a market participant would use in pricing the asset or liability (examples include certain private equity investments, certain residential and commercial mortgage-related assets (including loans, securities and derivatives), and long-dated or complex derivatives (including certain equity and currency derivatives and long-dated options on gas and power)).
 
As required by SFAS No. 157, when the inputs used to measure fair value fall within different levels of the hierarchy, the level within which the fair value measurement is categorized is based on the lowest level input that is significant to the fair value measurement in its entirety. For example, a Level 3 fair value measurement may include inputs that are observable (Levels 1 and 2) and unobservable (Level 3). Therefore gains and losses for such assets and liabilities categorized within the Level 3 table below may include changes in fair value that are attributable to both observable inputs (Levels 1 and 2) and unobservable inputs (Level 3). Further, it should be noted that the following tables do not take into consideration the effect of offsetting Level 1 and 2 financial instruments entered into by Merrill Lynch that economically hedge certain exposures to the Level 3 positions.
 
A review of fair value hierarchy classifications is conducted on a quarterly basis. Changes in the observability of valuation inputs may result in a reclassification for certain financial assets or liabilities. Reclassifications impacting Level 3 of the fair value hierarchy are reported as transfers in/out of the Level 3 category as of the beginning of the quarter in which the reclassifications occur. Refer to the recurring and non-recurring sections within this Note for further information on the net transfers in and out during the quarter.


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Recurring Fair Value
 
The following tables present Merrill Lynch’s fair value hierarchy for those assets and liabilities measured at fair value on a recurring basis as of June 27, 2008 and December 28, 2007, respectively.
 
                                         
(dollars in millions)
    Fair Value Measurements on a Recurring Basis
    as of June 27, 2008
                Netting
   
    Level 1   Level 2   Level 3   Adj(1)   Total
 
 
Assets:
                                       
Securities segregated for regulatory purposes or deposited with clearing organizations
  $ 1,727     $ 6,788     $ -     $ -     $ 8,515  
Receivables under resale agreements(2)
    -       105,047       -       -       105,047  
Receivables under securities borrowed transactions
    -       1,201       -       -       1,201  
Trading assets, excluding derivative contracts
    43,107       67,850       20,190       -       131,147  
Derivative contracts
    5,930       686,792       33,127       (639,357 )     86,492  
Investment securities
    2,843       45,419       4,589       -       52,851  
Securities received as collateral
    45,869       5,636       -               51,505  
Loans, notes, and mortgages
    -       1,205       172       -       1,377  
Other assets(3)
    30       1,035       -       (17 )     1,048  
Liabilities:
                                       
Payables under repurchase agreements(2)
    -       81,193       -       -       81,193  
Short-term borrowings
    -       3,078       34       -       3,112  
Trading liabilities, excluding derivative contracts
    35,404       4,664       -       -       40,068  
Derivative contracts
    5,767       680,413       34,419       (654,691 )     65,908  
Obligation to return securities received as collateral
    45,869       5,636       -       -       51,505  
Long-term borrowings(4)
    -       81,575       12,749       -       94,324  
Other payables — interest and other(3)
    -       487       -       (17 )     470  
 
 
(1) Represents counterparty and cash collateral netting.
(2) Resale and repurchase agreements are shown gross of counterparty netting.
(3) Primarily represents certain derivatives used for non-trading purposes.
(4) Includes bifurcated embedded derivatives carried at fair value.
 


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Level 3 trading assets primarily include U.S. super senior ABS CDOs of $10.1 billion, corporate bonds and loans of $6.9 billion and auction rate securities of $1.6 billion.
 
Level 3 derivative contracts (assets) primarily relate to derivative positions on U.S. super senior ABS CDOs of $9.9 billion, $13.6 billion of other credit derivatives that incorporate unobservable correlation, and $9.2 billion of equity, currency, interest rate and commodity derivatives that are long-dated and/or have unobservable correlation.
 
Level 3 investment securities primarily relate to certain private equity and principal investment positions of $4.3 billion.
 
Level 3 derivative contracts (liabilities) primarily relate to derivative positions on U.S. super senior ABS CDOs of $15.4 billion, $10.8 billion of other credit derivatives that incorporate unobservable correlation, and $6.6 billion of equity and currency derivatives that are long-dated and/or have unobservable correlation.
 
Level 3 long-term borrowings primarily relate to structured notes with embedded equity and commodity derivatives of $10.7 billion that are long-dated and/or have unobservable correlation and $1.7 billion related to certain non-recourse long-term borrowings issued by consolidated special purpose entities (“SPEs”).
 
                                         
(dollars in millions)
    Fair Value Measurements on a Recurring Basis
    as of December 28, 2007
                Netting
   
    Level 1   Level 2   Level 3   Adj(1)   Total
 
 
Assets:
                                       
Securities segregated for regulatory purposes or deposited with clearing organizations
  $ 1,478     $ 5,595     $ 84     $ -     $ 7,157  
Receivables under resale agreements(2)
    -       100,214       -       -       100,214  
Trading assets, excluding derivative contracts
    71,038       81,169       9,773       -       161,980  
Derivative contracts
    4,916       522,014       26,038       (480,279 )     72,689  
Investment securities
    2,240       53,403       5,491       -       61,134  
Securities received as collateral
    42,451       2,794       -       -       45,245  
Loans, notes, and mortgages
    -       1,145       63       -       1,208  
Other assets(3)
    7       1,739       -       (24 )     1,722  
Liabilities:
                                       
Payables under repurchase agreements(2)
    -       89,733       -       -       89,733  
Trading liabilities, excluding derivative contracts
    43,609       6,685       -       -       50,294  
Derivative contracts
    5,562       526,780       35,107       (494,155 )     73,294  
Obligation to return securities received as collateral
    42,451       2,794       -       -       45,245  
Long-term borrowings(4)
    -       75,984       4,765       -       80,749  
Other payables — interest and other(3)
    2       287       -       (13 )     276  
 
 
(1) Represents counterparty and cash collateral netting.
(2) Resale and repurchase agreements are shown gross of counterparty netting.
(3) Primarily represents certain derivatives used for non-trading purposes.
(4) Includes bifurcated embedded derivatives carried at fair value.

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Level 3 Assets and Liabilities as of December 28, 2007
 
Level 3 trading assets primarily include corporate bonds and loans of $5.4 billion and U.S. ABS CDOs of $2.4 billion, of which $1.0 billion was sub-prime related.
 
Level 3 derivative contracts (assets) primarily relate to derivative positions on U.S. ABS CDOs of $18.9 billion, of which $14.7 billion is sub-prime related, and $5.1 billion of equity derivatives that are long-dated and/or have unobservable correlation.
 
Level 3 investment securities primarily relate to certain private equity and principal investment positions of $4.0 billion, as well as U.S. ABS CDOs of $834 million that are accounted for as trading securities under SFAS No. 115.
 
Level 3 derivative contracts (liabilities) primarily relate to derivative positions on U.S. ABS CDOs of $25.1 billion, of which $23.9 billion relates to sub-prime, and $8.3 billion of equity derivatives that are long-dated and/or have unobservable correlation.
 
Level 3 long-term borrowings primarily relate to structured notes with embedded long-dated equity and currency derivatives.
 
The following tables provide a summary of changes in fair value of Merrill Lynch’s Level 3 financial assets and liabilities for the three and six months ended June 27, 2008 and June 29, 2007, respectively.
 
                                                                 
(dollars in millions)
    Level 3 Financial Assets and Liabilities
    Three Months Ended June 27, 2008
        Total Realized and Unrealized
               
        Gains or (Losses)
  Total Realized and
  Purchases,
       
        included in Income   Unrealized Gains
  Issuances
       
    Beginning
  Principal
  Other
      or (Losses)
  and
  Transfers
  Ending
    Balance   Transactions   Revenue   Interest   included in Income   Settlements   in (out)   Balance
 
 
Assets:
                                                               
Securities segregated for regulatory purposes or deposited with clearing organizations
  $ 80     $ -     $ -     $ -     $ -     $ (80 )   $ -     $ -  
Trading assets
    18,225       (2,624 )     -       37       (2,587 )     2,134       2,418       20,190  
Investment securities
    4,932       (343 )     70       -       (273 )     (53 )     (17 )     4,589  
Loans, notes, and mortgages
    205       -       (3 )     (3 )     (6 )     (12 )     (15 )     172  
Liabilities:
                                                               
Short-term borrowings
    -       -       -       -       -       34       -       34  
Derivative contracts, net
    3,003       (1,122 )     -       -       (1,122 )     (4,125 )     1,292       1,292  
Long-term borrowings
    8,118       (1,169 )     14       -       (1,155 )     400       3,076       12,749  
 
 
 
Net losses in principal transactions during the quarter ended June 27, 2008 were due primarily to $5.8 billion of net losses related to U.S. super senior ABS CDO positions.
 
The increase in Level 3 trading assets and the decrease in derivative contracts, net due to purchases, issuances and settlements is primarily attributable to the recording of assets for which the exposure was previously recognized as derivative liabilities (total return swaps) at March 28, 2008. In the second quarter of 2008, Merrill Lynch purchased the assets underlying the total return swaps as the assets were downgraded and could no longer be held by the counterparty to the swap.
 
The Level 3 net transfers in for trading assets primarily relates to decreased observability of inputs on certain corporate bonds and loans. The Level 3 net transfers in for long-term borrowings were primarily due to decreased observability of inputs on certain long-dated equity linked notes.
 


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(dollars in millions)
    Level 3 Financial Assets and Liabilities
    Six Months Ended June 27, 2008
        Total Realized and Unrealized
               
        Gains or (Losses)
  Total Realized and
  Purchases,
       
        included in Income   Unrealized Gains
  Issuances
       
    Beginning
  Principal
  Other
      or (Losses)
  and
  Transfers
  Ending
    Balance   Transactions   Revenue   Interest   included in Income   Settlements   in (out)   Balance
 
 
Assets:
                                                               
Securities segregated for regulatory purposes or deposited with clearing organizations
  $ 84     $ -     $ -     $ 1     $ 1     $ (79 )   $ (6 )   $ -  
Trading assets
    9,773       (3,047 )     -       81       (2,966 )     10,399       2,984       20,190  
Investment securities
    5,491       (748 )     13       -       (735 )     98       (265 )     4,589  
Loans, notes, and mortgages
    63       -       (1 )     (3 )     (4 )     119       (6 )     172  
Liabilities:
                                                               
Short-term borrowings
    -       -       -       -       -       34       -       34  
Derivative contracts, net
    9,069       (1,057 )     -       5       (1,052 )     (12,119 )     3,290       1,292  
Long-term borrowings
    4,765       (1,617 )     14       -       (1,603 )     1,465       4,916       12,749  
 
 
 
Net losses in principal transactions for the six months ended June 27, 2008 were due primarily to $9.0 billion of net losses related to U.S. super senior ABS CDO positions, offset by $2.8 billion in gains on other credit derivatives that incorporate unobservable correlation.
 
The increase in Level 3 trading assets and the decrease in derivative contracts, net for the six months ended June 27, 2008 due to purchases, issuances and settlements is primarily attributable to the recording of assets for which the exposure was previously recognized as derivative liabilities (total return swaps) at December 28, 2007. In the first quarter of 2008, Merrill Lynch recorded certain of these positions as trading assets as a result of consolidating certain SPEs that held the underlying assets on which the total return swaps were referenced. As a result of the consolidation of the SPEs the total return swaps were eliminated in consolidation. In the second quarter of 2008, Merrill Lynch purchased the assets underlying the total return swaps as the assets were downgraded and could no longer be held by the counterparty to the swap.
 
The Level 3 net transfers in for trading assets primarily relates to decreased observability of inputs on certain corporate bonds and loans. The Level 3 net transfers in for derivative contracts were primarily due to the impact of the counterparty credit valuation adjustments to U.S. super senior ABS CDO positions. The Level 3 net transfers in for long-term borrowings were primarily due to decreased observability of inputs on certain long-dated equity linked notes.
 
                                                                 
(dollars in millions)
    Level 3 Financial Assets and Liabilities
    Three Months Ended June 29, 2007
        Total Realized and Unrealized
               
        Gains or (Losses)
  Total Realized and
  Purchases,
       
        included in Income   Unrealized Gains
  Issuances
       
    Beginning
  Principal
  Other
      or (Losses)
  and
  Transfers
  Ending
    Balance   Transactions   Revenue   Interest   included in Income   Settlements   in (out)   Balance
 
 
Assets:
                                                               
Trading assets
  $ 2,324     $ 259     $ -     $ 32     $ 291     $ 483     $ 550     $ 3,648  
Investment securities
    5,922       (295 )     185       5       (105 )     568       (601 )     5,784  
Loans, notes, and mortgages
    6       -       (5 )     -       (5 )     (1 )     4       4  
Liabilities:
                                                               
Derivative contracts, net
    1,357       416       5       1       422       (249 )     (915 )     (229 )
Long-term borrowings
    -       -       -       -       -       -       282       282  
 
 
 

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(dollars in millions)
    Level 3 Financial Assets and Liabilities
    Six Months Ended June 29, 2007
        Total Realized and Unrealized
               
        Gains or (Losses)
  Total Realized and
  Purchases,
       
        included in Income   Unrealized Gains
  Issuances
       
    Beginning
  Principal
  Other
      or (Losses)
  and
  Transfers
  Ending
    Balance   Transactions   Revenue   Interest   included in Income   Settlements   in (out)   Balance
 
 
Assets:
                                                               
Trading assets
  $ 2,021     $ 253     $ -     $ 28     $ 281     $ 503     $ 843     $ 3,648  
Investment securities
    5,117       (430 )     480       5       55       1,204       (592 )     5,784  
Loans, notes, and mortgages
    7       -       (9 )     -       (9 )     (2 )     8       4  
Liabilities:
                                                               
Derivative contracts, net
    2,030       571       5       6       582       (807 )     (870 )     (229 )
Long-term borrowings
    -       -       -       -       -       -       282       282  
 
 
 
The following tables provide the portion of gains or losses included in income for the three and six months ended June 27, 2008 and June 29, 2007 attributable to unrealized gains or losses relating to those Level 3 assets and liabilities still held at June 27, 2008 and June 29, 2007, respectively.
 
                                                                 
(dollars in millions)
    Unrealized Gains or (Losses) for Level 3 Assets and Liabilities Still Held at June 27, 2008
    Three Months Ended June 27, 2008   Six Months Ended June 27, 2008
     
    Principal
  Other
          Principal
  Other
       
    Transactions   Revenue   Interest   Total   Transactions   Revenue   Interest   Total
 
 
Assets:
                                                               
Securities segregated for regulatory purposes or deposited with clearing organizations
  $ -     $ -     $ -     $ -     $ -     $ -     $ 1     $ 1  
Trading assets
    (2,623 )     -       59       (2,564 )     (3,047 )     -       103       (2,944 )
Investment securities
    (318 )     66       -       (252 )     (723 )     9       -       (714 )
Loans, notes, and mortgages
    -       -       (3 )     (3 )     -       6       (3 )     3  
Liabilities:
                                                               
Derivative contracts, net
    (1,209 )     -       -       (1,209 )     (1,115 )     -       5       (1,110 )
Long-term borrowings
    (1,126 )     14       -       (1,112 )     (1,575 )     14       -       (1,561 )
 
 
 
Net losses in principal transactions for the three months ended June 27, 2008 were primarily due to $5.8 billion of net losses on U.S. super senior ABS CDO related assets and liabilities.
 
For the six months ended June 27, 2008, net unrealized losses were primarily due to $9.0 billion of net losses on U.S. super senior ABS CDO related assets and liabilities. These losses were offset by $2.8 billion in gains on other credit derivatives that incorporate unobservable correlation.
 
                                                                 
(dollars in millions)
    Unrealized Gains or (Losses) for Level 3 Assets and Liabilities Still Held at June 29, 2007
    Three Months Ended June 29, 2007   Six Months Ended June 29, 2007
     
    Principal
  Other
          Principal
  Other
       
    Transactions   Revenue   Interest   Total   Transactions   Revenue   Interest   Total
 
 
Assets:
                                                               
Trading assets
  $ 234     $ -     $ 32     $ 266     $ 203     $ -     $ 28     $ 231  
Investment securities
    (295 )     189       5       (101 )     (430 )     396       5       (29 )
Loans, notes, and mortgages
    -       1       -       1       -       3       -       3  
Liabilities:
                                                               
Derivative contracts, net
    336       5       1       342       460       -       6       466  
 
 
 
Non-recurring Fair Value
 
Certain assets and liabilities are measured at fair value on a non-recurring basis and are not included in the tables above. These assets and liabilities primarily include loans and loan commitments held for sale and reported at lower of cost or market and loans held for investment that were initially measured

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at cost and have been written down to fair value as a result of an impairment. The following table shows the fair value hierarchy for those assets and liabilities measured at fair value on a non-recurring basis as of June 27, 2008 and December 28, 2007, respectively.
 
                                                 
(dollars in millions)
        Gains / (Losses)   Gains / (Losses)
    Non-Recurring Basis as of June 27, 2008   Three Months Ended
  Six Months Ended
    Level 1   Level 2   Level 3   Total   June 27, 2008   June 27, 2008
 
 
Assets:
                                               
Loans, notes, and mortgages
  $ -     $ 15,080     $ 6,117     $ 21,197     $ (53 )   $ (1,275 )
Liabilities:
                                               
Other liabilities
    -       651       -       651       45       (7 )
 
 
 
 
 
                                 
(dollars in millions)
    Non-Recurring Basis
    as of December 28, 2007
    Level 1   Level 2   Level 3   Total
 
 
Assets:
                               
Loans, notes, and mortgages
  $ -     $ 32,594     $ 7,157     $ 39,751  
Liabilities:
                               
Other liabilities
    -       666       -       666  
 
 
 
Loans, notes, and mortgages include held for sale loans that are carried at the lower of cost or market and for which the fair value was below the cost basis at June 27, 2008 and/or December 28, 2007. It also includes certain impaired held for investment loans where an allowance for loan losses has been calculated based upon the fair value of the loans or collateral. Level 3 assets as of June 27, 2008 primarily relate to U.K. residential real estate loans of $5.2 billion that are classified as held for sale where there continues to be significant illiquidity in the securitization market. The losses on the Level 3 loans were calculated primarily by a fundamental cash flow valuation analysis. This cash flow analysis includes cumulative loss and prepayment assumptions derived from multiple inputs including mortgage remittance reports, property prices and other market data. Level 3 assets as of December 28, 2007 primarily related to residential and commercial real estate loans that are classified as held for sale in the United Kingdom of $4.1 billion.
 
Other liabilities include amounts recorded for loan commitments at lower of cost or fair value where the funded loan will be held for sale, particularly leveraged loan commitments in the U.S. The losses were calculated by models incorporating significant observable market data.
 
Fair Value Option
 
SFAS No. 159 provides a fair value option election that allows companies to irrevocably elect fair value as the initial and subsequent measurement attribute for certain financial assets and liabilities. Changes in fair value for assets and liabilities for which the election is made will be recognized in earnings as they occur. SFAS No. 159 permits the fair value option election on an instrument by instrument basis at initial recognition of an asset or liability or upon an event that gives rise to a new basis of accounting for that instrument. As discussed above, certain of Merrill Lynch’s financial instruments are required to be accounted for at fair value under SFAS No. 115 and SFAS No. 133, as well as industry level guidance. For certain financial instruments that are not accounted for at fair value under other applicable accounting guidance, the fair value option has been elected.


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The following tables provide information about where in the Condensed Consolidated Statements of (Loss)/Earnings changes in fair values of assets and liabilities, for which the fair value option has been elected, are included for the three and six months ended June 27, 2008 and June 29, 2007, respectively.
 
                                                 
(dollars in millions)
    Changes in Fair Value For the Three
  Changes in Fair Value For the Six
    Months Ended June 27,
  Months Ended June 27,
    2008, for Items Measured at Fair Value
  2008, for Items Measured at Fair Value
    Pursuant to Fair Value Option   Pursuant to Fair Value Option
    Gains/
      Total
  Gains/
      Total
    (losses)
  Gains/(losses)
  Changes
  (losses)
  Gains/(losses)
  Changes
    Principal
  Other
  in Fair
  Principal
  Other
  in Fair
    Transactions   Revenues   Value   Transactions   Revenues   Value
 
 
Assets:
                                               
Receivables under resale agreements
  $ (178 )   $ -     $ (178 )   $ (209 )   $ -     $ (209 )
Receivables under securities borrowed transactions
    -       -       -       -       -       -  
Investment securities
    247       (1 )     246       (83 )     (39 )     (122 )
Loans, notes, and mortgages
    11       -       11       3       12       15  
Liabilities:
                                               
Payables under repurchase agreements
    63       -       63       48       -       48  
Short-term borrowings
    379       -       379       182       -       182  
Long-term borrowings
    1,263       370       1,633       4,509       869       5,378  
 
 
                                                 
                                                 
 
                                                 
(dollars in millions)
    Changes in Fair Value For the Three
  Changes in Fair Value For the Six
    Months Ended June 29,
  Months Ended June 29,
    2007, for Items Measured at Fair
  2007, for Items Measured at Fair
    Value Pursuant to Fair Value Option   Value Pursuant to Fair Value Option
    Gains/
  Gains/
  Total
  Gains/
  Gains/
  Total
    (losses)
  (losses)
  Changes
  (losses)
  (losses)
  Changes
    Principal
  Other
  in Fair
  Principal
  Other
  in Fair
    Transactions   Revenues   Value   Transactions   Revenues   Value
 
 
Assets:
                                               
Receivables under resale agreements
  $ 6     $ -     $ 6     $ 5     $ -     $ 5  
Investment securities
    210       8       218       210       21       231  
Loans, notes, and mortgages
    -       20       20       2       40       42  
Liabilities:
                                               
Payables under repurchase agreements
    7       -       7       17       -       17  
Long-term borrowings
    985       -       985       838       -       838  
 
 
 
The following describes the rationale for electing to account for certain financial assets and liabilities at fair value, as well as the impact of instrument-specific credit risk on the fair value.
 
Resale and repurchase agreements:
 
Merrill Lynch elected the fair value option on a prospective basis for certain resale and repurchase agreements. The fair value option election was made based on the tenor of the resale and repurchase agreements, which reflects the magnitude of the interest rate risk. The majority of resale and repurchase agreements collateralized by U.S. government securities were excluded from the fair value option election as these contracts are generally short-dated and therefore the interest rate risk is not considered significant. Amounts loaned under resale agreements require collateral with a market value equal to or in excess of the principal amount loaned resulting in minimal credit risk for such transactions.
 
Securities borrowed transactions:
 
Merrill Lynch elected the fair value option for certain Japanese government bond borrowing transactions during the second quarter of 2008. Fair value changes related to such transactions were immaterial for the three and six months ended June 27, 2008.


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Investment securities:
 
At June 27, 2008 investment securities primarily represented non-marketable convertible preferred shares for which Merrill Lynch has economically hedged a majority of the position with derivatives.
 
Loans, notes, and mortgages:
 
Merrill Lynch elected the fair value option for automobile and certain corporate loans because the loans are risk managed on a fair value basis. The change in the fair value of loans, notes, and mortgages for which the fair value option was elected that was attributable to changes in borrower-specific credit risk was not material for the three and six months ended June 27, 2008 and for the three and six months ended June 29, 2007.
 
For those loans, notes and mortgages for which the fair value option has been elected, the aggregate fair value of loans that are 90 days or more past due and in non-accrual status are not material to the Condensed Consolidated Financial Statements.
 
Short-term and long-term borrowings:
 
Merrill Lynch elected the fair value option for certain short-term and long-term borrowings that are risk managed on a fair value basis, including structured notes, and for which hedge accounting under SFAS No. 133 had been difficult to obtain. The changes in the fair value of liabilities for which the fair value option was elected that was attributable to changes in Merrill Lynch credit spreads were estimated gains of $91 million and $2.2 billion for the three and six months ended June 27, 2008, respectively. The changes in the fair value of liabilities for which the fair value option was elected that were attributable to changes in Merrill Lynch credit spreads were not material for the three and six months ended June 29, 2007. Changes in Merrill Lynch specific credit risk are derived by isolating fair value changes due to changes in Merrill Lynch’s credit spreads as observed in the secondary cash market.
 
The fair value option was also elected for certain non-recourse long-term borrowings issued by consolidated SPEs. The fair value of these long-term borrowings is unaffected by changes in Merrill Lynch’s creditworthiness.
 
The following tables present the difference between fair values and the aggregate contractual principal amounts of receivables under resale agreements, receivables under securities borrowed transactions, loans, notes, and mortgages and short-term and long-term borrowings for which the fair value option has been elected as of June 27, 2008 and December 28, 2007, respectively.
 
                         
(dollars in millions)
        Principal
   
    Fair Value
  Amount
   
    at
  Due Upon
   
    June 27, 2008   Maturity   Difference
 
 
Assets:
                       
Receivables under resale agreements
  $ 105,047     $ 104,970     $ 77  
Receivables under securities borrowed transactions
    1,201       1,201       -  
Loans, notes and mortgages(1)
    1,204       1,395       (191 )
Liabilities:
                       
Payables under repurchase agreements
    81,193       81,233       (40 )
Short-term borrowings
    3,112       3,158       (46 )
Long-term borrowings(2)
    91,667       93,635       (1,968 )
 
 
(1) The majority of the difference relates to loans purchased at a substantial discount from the principal amount.
(2) The majority of the difference relates to the impact of the widening of Merrill Lynch’s credit spreads, the change in fair value of non-recourse debt, and zero coupon notes issued at a substantial discount from the principal amount.
 


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(dollars in millions)
    Fair Value
  Principal
   
    at
  Amount
   
    December 28,
  Due Upon
   
    2007   Maturity   Difference
 
 
Assets:
                       
Receivables under resale agreements
  $ 100,214     $ 100,090     $ 124  
Loans, notes and mortgages(1)
    1,149       1,355       (206 )
Liabilities:
                       
Long-term borrowings(2)
    76,334       81,681       (5,347 )
 
 
(1) The majority of the difference relates to loans purchased at a substantial discount from the principal amount.
(2) The majority of the difference relates to the impact of the widening of Merrill Lynch’s credit spreads, the change in fair value of non-recourse debt, and zero coupon notes issued at a substantial discount from the principal amount.
 
Trading Risk Management
 
Trading activities subject Merrill Lynch to market and credit risks. These risks are managed in accordance with established risk management policies and procedures. Specifically, the independent risk and control groups work to ensure that these risks are properly identified, measured, monitored, and managed throughout Merrill Lynch. Refer to Note 3 of the 2007 Annual Report for further information on trading risk management.
 
Concentration of Risk to the Mortgage Markets
 
At June 27, 2008, Merrill Lynch had sizeable exposure to the mortgage market through securities, derivatives, loans and loan commitments. This included:
•  Net exposures of $33.7 billion in U.S. Prime residential mortgage-related positions and $10.0 billion in other residential mortgage-related positions, excluding Merrill Lynch’s U.S. banks investment securities portfolio;
•  Net exposure of $4.5 billion in super senior U.S. ABS CDOs and related secondary trading exposures;
•  Net exposure of $18.0 billion in Merrill Lynch’s U.S. banks investment securities portfolio; and
•  Net exposure of $14.9 billion in commercial real estate related positions, excluding First Republic, and $2.7 billion in First Republic commercial real estate related positions.
 
Valuation of these exposures will continue to be impacted by external market factors including default rates, rating agency actions, and the prices at which observable market transactions occur. Merrill Lynch’s ability to mitigate its risk by selling or hedging its exposures is also limited by the market environment. Merrill Lynch’s future results may continue to be materially impacted by the valuation adjustments applied to these positions.
 
Concentration of Risk to Monoline Financial Guarantors
 
To economically hedge certain U.S. super senior ABS CDOs and U.S. sub-prime mortgage positions, Merrill Lynch entered into credit derivatives with various counterparties, including financial guarantors. At June 27, 2008, Merrill Lynch’s short exposure (i.e., purchases of credit protection) from credit default swaps with financial guarantors to economically hedge certain U.S. super senior ABS CDOs was $9.6 billion, which represented credit default swaps with a notional amount of $18.7 billion that have been adjusted for mark-to-market gains of $9.1 billion. The fair value of these credit default swaps at June 27, 2008 was $2.9 billion, after taking into account life-to-date credit valuation adjustments of $6.2 billion related to certain financial guarantors. Merrill Lynch also has credit derivatives with financial guarantors on other referenced assets. The fair value of these credit

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derivatives at June 27, 2008 was $3.6 billion, after taking into account life-to-date credit valuation adjustments of $2.8 billion.
 
Subsequent to the end of the second quarter of 2008, Merrill Lynch entered into an agreement to sell $30.6 billion gross notional amount of U.S. super senior ABS CDOs. These CDOs were carried at $11.1 billion at the end of the second quarter of 2008. Additionally, Merrill Lynch agreed to terminate all of its CDO-related hedges with monoline guarantor XL Capital Assurance Inc. (“XL”) and is in the process of negotiating settlements on certain contracts with other monoline counterparties. Refer to Note 18 for further details.
 
Note 4.  Securities Financing Transactions
 
Merrill Lynch enters into secured borrowing and lending transactions in order to meet customers’ needs and earn residual interest rate spreads, obtain securities for settlement and finance trading inventory positions.
 
Under these transactions, Merrill Lynch either receives or provides collateral, including U.S. Government and agencies, asset-backed, corporate debt, equity, and non-U.S. governments and agencies securities. Merrill Lynch receives collateral in connection with resale agreements, securities borrowed transactions, customer margin loans, and other loans. Under many agreements, Merrill Lynch is permitted to sell or repledge the securities received (e.g., use the securities to secure repurchase agreements, enter into securities lending transactions, or deliver to counterparties to cover short positions). At June 27, 2008 and December 28, 2007, the fair value of securities received as collateral where Merrill Lynch is permitted to sell or repledge the securities was $865 billion and $853 billion, respectively, and the fair value of the portion that has been sold or repledged was $622 billion and $675 billion, respectively. Merrill Lynch may use securities received as collateral for resale agreements to satisfy regulatory requirements such as Rule 15c3-3 of the SEC. The fair value of collateral used for this purpose was $16.7 billion and $19.3 billion at June 27, 2008 and December 28, 2007, respectively.
 
Merrill Lynch additionally receives securities as collateral in connection with certain securities transactions in which Merrill Lynch is the lender. In instances where Merrill Lynch is permitted to sell or repledge securities received, Merrill Lynch reports the fair value of such securities received as collateral and the related obligation to return securities received as collateral in the Condensed Consolidated Balance Sheets.
 
Merrill Lynch pledges assets to collateralize repurchase agreements and other secured financings. Pledged securities that can be sold or repledged by the secured party are parenthetically disclosed in trading assets and investment securities on the Condensed Consolidated Balance Sheets. The parenthetically disclosed amount for December 28, 2007 relating to trading assets has been restated from approximately $79 billion (as previously reported) to approximately $45 billion to properly reflect the amount of pledged securities that can be sold or repledged by the secured party. The carrying value and classification of securities owned by Merrill Lynch that have been pledged to counterparties where


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those counterparties do not have the right to sell or repledge at June 27, 2008 and December 28, 2007 are as follows:
 
                 
(dollars in millions)        
 
    June 27,
  Dec. 28,
    2008   2007
 
Trading asset category
               
Mortgages, mortgage-backed, and asset-backed securities
  $ 20,881     $ 11,873  
U.S. Government and agencies
    5,729       11,110  
Corporate debt and preferred stock
    16,170       17,144  
Non-U.S. governments and agencies
    1,606       2,461  
Equities and convertible debentures
    7,906       9,327  
Municipals and money markets
    733       450  
                 
Total
  $ 53,025     $ 52,365  
 
Note 5.  Investment Securities
 
Investment securities on the Condensed Consolidated Balance Sheets include:
 
•   SFAS No. 115 investments held by ML & Co.  and certain of its non-broker-dealer entities, including Merrill Lynch banks. SFAS No. 115 investments consist of:
  •   Debt securities, including debt held for investment and liquidity and collateral management purposes that are classified as available-for-sale, debt securities held for trading purposes, and debt securities that Merrill Lynch intends to hold until maturity;
  •   Marketable equity securities, which are generally classified as available-for-sale.
•   Non-qualifying investments are those that do not fall within the scope of SFAS No. 115. Non-qualifying investments consist principally of:
  •   Equity investments, including investments in partnerships and joint ventures. Included in equity investments are investments accounted for under the equity method of accounting, which consist of investments in (i) partnerships and certain limited liability corporations where Merrill Lynch has more than minor influence (i.e. generally defined as greater than a three percent interest) and (ii) corporate entities where Merrill Lynch has the ability to exercise significant influence over the investee (i.e. generally defined as ownership and voting interest of 20% to 50%). For information related to our investments accounted for under the equity method, please refer to Note 5 of the 2007 Annual Report. Also included in equity investments are private equity investments that Merrill Lynch holds for capital appreciation and/or current income and which are accounted for at fair value in accordance with the Investment Company Guide, as well as private equity investments accounted for at fair value under the fair value option election in SFAS No. 159. The carrying value of private equity investments reflects expected exit values based upon market prices or other valuation methodologies including discounted expected cash flows and market comparables of similar companies.
  •   Deferred compensation hedges, which are investments economically hedging deferred compensation liabilities and are accounted for at fair value.


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Investment securities reported on the Condensed Consolidated Balance Sheets at June 27, 2008 and December 28, 2007 are as follows:
 
                 
(dollars in millions)
 
    June 27,
  Dec. 28,
    2008   2007
 
Investment securities
               
Available-for-sale(1)
  $ 43,819     $ 50,922  
Trading
    3,848       5,015  
Held-to-maturity
    271       267  
Non-qualifying(2)
               
Equity investments(3)
    27,889       29,623  
Deferred compensation hedges(4)
    1,639       1,710  
Investments in trust preferred securities and other investments
    435       438  
                 
Total
  $ 77,901     $ 87,975  
(1) At June 27, 2008 and December 28, 2007, includes $6.6 billion and $5.4 billion, respectively, of investment securities reported in cash and securities segregated for regulatory purposes or deposited with clearing organizations.
(2) Non-qualifying for SFAS No. 115 purposes.
(3) Includes Merrill Lynch’s investment in BlackRock.
(4) Represents investments that economically hedge deferred compensation liabilities.
 
Included in available-for-sale investment securities above are certain mortgage- and asset-backed securities held in Merrill Lynch’s U.S. banks investment securities portfolio. The fair values of most of these mortgage- and asset-backed securities have declined below the respective security’s amortized cost basis. Changes in fair value are initially captured in the financial statements by reporting the securities at fair value with the cumulative change in fair value reported in accumulated other comprehensive (loss)/income, a component of shareholder’s equity. Merrill Lynch regularly (at least quarterly) evaluates each security whose value has declined below amortized cost to assess whether the decline in fair value is other-than-temporary. If the decline in fair value is determined to be other-than-temporary, the cost basis of the security is reduced to an amount equal to the fair value of the security at the time of impairment (the new cost basis), and the amount of the reduction in cost basis is recorded in earnings.
 
A decline in a debt security’s fair value is considered to be other-than-temporary if it is probable that not all amounts contractually due will be collected. In assessing whether it is probable that not all amounts contractually due will be collected, Merrill Lynch considers the following:
•   Whether there has been an adverse change in the estimated cash flows of the security;
•   The period of time over which it is estimated that the fair value will increase from the current level to at least the amortized cost level, or until principal is estimated to be received;
•   The period of time a security’s fair value has been below amortized cost;
•   The amount by which the security’s fair value is below amortized cost;
•   The financial condition of the issuer; and
•   Management’s ability and intent to hold the security until fair value recovers or until the principal is received.
 
The determination of whether a security is other-than-temporarily impaired is based, in large part, on estimates and assumptions related to the prepayment and default rates of the loans collateralizing the securities, the loss severities experienced on the sale of foreclosed properties, and other matters affecting the security’s underlying cash flows. The cash flow estimates and assumptions used to assess whether an adverse change has occurred as well as the other factors affecting the other-than-temporary


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determination are regularly reviewed and revised, incorporating new information as it becomes available and due to changes in market conditions.
 
For all securities including those securities that are deemed to be other-than-temporarily impaired based on specific analysis described above, management must conclude on whether it has the intent and ability to hold the securities to recovery. To that end, management has considered its ability and intent to hold available-for-sale securities relative to the cash flow requirements of Merrill Lynch’s operating, investing and financing activities and has determined that it has the ability and intent to hold the securities with unrealized losses until the fair value recovers to an amount at least equal to the amortized cost or principal is received.
 
Other-than-temporary impairments related to Merrill Lynch’s U.S. banks investment securities portfolio, which are recorded within other revenues on the Condensed Consolidated Statement of (Loss)/Earnings, have been recognized for the three and six month periods ended June 27, 2008 as follows:
 
                 
(dollars in millions)
 
    Three Months Ended
  Six Months Ended
    June 27, 2008   June 27, 2008
 
Security Description
               
Prime
  $ 223     $ 227  
Alt A
    1,373       1,544  
Sub-prime
    80       94  
CDOs
    28       221  
                 
Total
  $ 1,704     $ 2,086  
 
The cumulative pre-tax balance in other comprehensive loss related to the U.S. banks investment securities portfolio was approximately negative $4.7 billion as of June 27, 2008.
 
Note 6.  Securitization Transactions and Transactions with Special Purpose Entities (“SPEs”)
 
Securitizations
 
In the normal course of business, Merrill Lynch securitizes commercial and residential mortgage loans, municipal, government, and corporate bonds, and other types of financial assets. SPEs, often referred to as VIEs are often used when entering into or facilitating securitization transactions. Merrill Lynch’s involvement with SPEs used to securitize financial assets includes: structuring and/or establishing SPEs; selling assets to SPEs; managing or servicing assets held by SPEs; underwriting, distributing, and making loans to SPEs; making markets in securities issued by SPEs; engaging in derivative transactions with SPEs; owning notes or certificates issued by SPEs; and/or providing liquidity facilities and other guarantees to, or for the benefit of, SPEs.
 
Merrill Lynch securitized assets of approximately $16.0 billion and $126.3 billion for the six months ended June 27, 2008 and June 29, 2007, respectively. For the six months ended June 27, 2008 and June 29, 2007, Merrill Lynch received $17.0 billion and $128.1 billion, respectively, of proceeds, and other cash inflows, from securitization transactions, and recognized net securitization gains of $6 million and $206.5 million, respectively, in Merrill Lynch’s Condensed Consolidated Statements of (Loss)/Earnings.


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The table below summarizes the cash inflows received by Merrill Lynch from securitization transactions related to the following underlying asset types:
 
                 
(dollars in millions)
 
    Six Months Ended
    June 27,
  June 29,
    2008   2007
 
Asset category
               
Residential mortgage loans
  $ 10,386     $ 81,172  
Municipal bonds
    4,703       36,588  
Commercial loans and corporate bonds
    1,483       8,869  
Other
    413       1,474  
                 
Total
  $ 16,985     $ 128,103  
 
In certain instances, Merrill Lynch retains interests in the senior tranche, subordinated tranche, and/or residual tranche of securities issued by certain SPEs created to securitize assets. The gain or loss on the sale of the assets is determined with reference to the previous carrying amount of the financial assets transferred, which is allocated between the assets sold and the retained interests, if any, based on their relative fair value at the date of transfer.
 
Retained interests are recorded in the Condensed Consolidated Balance Sheets at fair value. To obtain fair values, observable market prices are used if available. Where observable market prices are unavailable, Merrill Lynch generally estimates fair value initially and on an ongoing basis based on the present value of expected future cash flows using management’s best estimates of credit losses, prepayment rates, forward yield curves, and discount rates, commensurate with the risks involved. Retained interests are either held as trading assets, with changes in fair value recorded in the Condensed Consolidated Statements of (Loss)/Earnings, or as securities available-for-sale, with changes in fair value included in accumulated other comprehensive loss. Retained interests held as available-for-sale are reviewed periodically for impairment.
 
Retained interests in securitized assets were approximately $3.5 billion and $6.1 billion at June 27, 2008 and December 28, 2007, respectively, which related primarily to residential mortgage loan, municipal bond, and commercial loan and corporate bond securitization transactions. As a result of the illiquidity in the mortgage-backed securities market, the majority of the mortgage-backed securities retained interest balance had limited price transparency at June 27, 2008 and December 28, 2007. The majority of these retained interests include mortgage-backed securities that Merrill Lynch had expected to sell to investors in the normal course of its underwriting activity. However, the timing of any sale is subject to current and future market conditions. A portion of the retained interests represent residual interests in U.S. sub-prime mortgage securitizations and is included in the Level 3 U.S. ABS CDO exposure disclosed in Note 3 to the Condensed Consolidated Financial Statements.
 
The following table presents information on retained interests, excluding the offsetting benefit of financial instruments used to hedge risks, held by Merrill Lynch as of June 27, 2008 arising from Merrill Lynch’s residential mortgage loan, municipal bond, and commercial loan and corporate bond


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securitization transactions. The pre-tax sensitivities of the current fair value of the retained interests to immediate 10% and 20% adverse changes in assumptions and parameters are also shown.
 
                         
(dollars in millions)
 
    Residential
      Commercial Loans
    Mortgage
  Municipal
  and Corporate
    Loans   Bonds   Bonds
 
Retained interest amount
  $ 1,417     $ 1,108     $ 977  
Weighted average credit losses (rate per annum)
    0.7 %     0.0 %     1.0 %
Range
    0-7.8 %     0.0 %     0-5.0 %
Impact on fair value of 10% adverse change
  $ (7 )   $ -     $ (2 )
Impact on fair value of 20% adverse change
  $ (14 )   $ -     $ (4 )
Weighted average discount rate
    11.9 %     2.3 %     3.5 %
Range
    0-100 %     1.6-8.2 %     0-35.0 %
Impact on fair value of 10% adverse change
  $ (43 )   $ (51 )   $ (11 )
Impact on fair value of 20% adverse change
  $ (92 )   $ (99 )   $ (23 )
Weighted average life (in years)
    5.0       9.9       4.8  
Range
    0-28.4       7.2-11.5       0-9.1  
Weighted average prepayment speed (CPR)(1)
    18.5 %     29.0 %     25.0 %
Range(1)
    0-54 %     0-35.9 %     0-96 %
Impact on fair value of 10% adverse change
  $ (27 )   $ -     $ (3 )
Impact on fair value of 20% adverse change
  $ (50 )   $ -     $ (5 )
 
CPR=Constant Prepayment Rate
(1) Relates to select securitization transactions where assets are prepayable.
 
The preceding sensitivity analysis is hypothetical and should be used with caution. In particular, the effect of a variation in a particular assumption on the fair value of the retained interest is calculated independent of changes in any other assumption; in practice, changes in one factor may result in changes in another, which might magnify or counteract the sensitivities. Further, changes in fair value based on a 10% or 20% variation in an assumption or parameter generally cannot be extrapolated because the relationship of the change in the assumption to the change in fair value may not be linear. Also, the sensitivity analysis does not include the offsetting benefit of financial instruments that Merrill Lynch utilizes to hedge risks, including credit, interest rate, and prepayment risk, that are inherent in the retained interests. These hedging strategies are structured to take into consideration the hypothetical stress scenarios above such that they would be effective in principally offsetting Merrill Lynch’s exposure to loss in the event these scenarios occur.
 
The weighted average assumptions and parameters used initially to value retained interests relating to securitizations that were still held by Merrill Lynch as of June 27, 2008 are as follows:
 
                         
    Residential
      Commercial Loans
    Mortgage
  Municipal
  and Corporate
    Loans   Bonds   Bonds
 
Credit losses (rate per annum)
    0.6 %     0.0 %     0.6 %
Weighted average discount rate
    5.8 %     4.6 %     2.6 %
Weighted average life (in years)
    4.9       7.8       5.6  
Prepayment speed assumption (CPR)(1)
    26.6 %     9.0 %     15.5 %
 
CPR = Constant Prepayment Rate
(1) Relates to select securitization transactions where assets are prepayable.
 
For residential mortgage loan and commercial loan and corporate bond securitizations, the investors and the securitization trust generally have no recourse to Merrill Lynch upon the event of a borrower


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default. See Note 11 to the Condensed Consolidated Financial Statements for information related to representations and warranties.
 
For municipal bond securitization SPEs, in the normal course of dealer market-making activities, Merrill Lynch acts as liquidity provider. Specifically, the holders of beneficial interests issued by municipal bond securitization SPEs have the right to tender their interests for purchase by Merrill Lynch on specified dates at a specified price. Beneficial interests that are tendered are then sold by Merrill Lynch to investors through a best efforts remarketing where Merrill Lynch is the remarketing agent. If the beneficial interests are not successfully remarketed, the holders of beneficial interests are paid from funds drawn under a standby liquidity letter of credit issued by Merrill Lynch.
 
In addition to standby letters of credit, Merrill Lynch also provides default protection or credit enhancement to investors in securities issued by certain municipal bond securitization SPEs. Interest and principal payments on beneficial interests issued by these SPEs are secured by a guarantee issued by Merrill Lynch. In the event that the issuer of the underlying municipal bond defaults on any payment of principal and/or interest when due, the payments on the bonds will be made to beneficial interest holders from an irrevocable guarantee by Merrill Lynch. Additional information regarding these commitments is provided in Note 11 to the Condensed Consolidated Financial Statements.
 
Mortgage Servicing Rights
 
In connection with its residential mortgage business, Merrill Lynch may retain or acquire servicing rights associated with certain mortgage loans that are sold through its securitization activities. These loan sale transactions create assets referred to as mortgage servicing rights, or MSRs, which are included within other assets on the Condensed Consolidated Balance Sheets.
 
Retained MSR’s are accounted for in accordance with SFAS No. 156, which requires all separately recognized servicing assets and servicing liabilities to be initially measured at fair value, if practicable. SFAS No. 156 also permits servicers to subsequently measure each separate class of servicing assets and liabilities at fair value rather than at the lower of amortized cost or market. Merrill Lynch has not elected to subsequently fair value retained MSRs.
 
Retained MSRs are initially recorded at fair value and subsequently amortized in proportion to and over the period of estimated future net servicing revenues. MSRs are assessed for impairment, at a minimum, on a quarterly basis. Management’s estimates of fair value of MSRs are determined using the net discounted present value of future cash flows, which consists of projecting future servicing cash flows and discounting such cash flows using an appropriate risk-adjusted discount rate. These valuations require various assumptions, including future servicing fees, servicing costs, credit losses, discount rates and mortgage prepayment speeds. Due to subsequent changes in economic and market conditions, these assumptions can, and generally will, change from quarter to quarter.
 
Changes in Merrill Lynch’s MSR balance are summarized below:
 
         
(dollars in millions)
 
    Carrying Value
 
 
Mortgage servicing rights, December 28, 2007 (fair value was $476)
  $ 389  
Additions
    1  
Amortization
    (71 )
Valuation allowance adjustments
    (46 )
         
Mortgage servicing rights, June 27, 2008 (fair value was $333)
  $ 273  


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The amount of contractually specified revenues for the three and six months ended June 27, 2008 and June 29, 2007, which are included within managed accounts and other fee-based revenues in the Condensed Consolidated Statements of (Loss)/Earnings include:
 
                                 
(dollars in millions)
 
    For the Three
  For the Six
    Months Ended   Months Ended
     
    June 27,
  June 29,
  June 27,
  June 29,
    2008   2007   2008   2007
 
Servicing fees
  $ 115     $ 92     $ 202     $ 166  
Ancillary and late fees
    14       16       32       30  
                                 
Total
  $ 129     $ 108     $ 234     $ 196  
 
The following table presents Merrill Lynch’s key assumptions used in measuring the fair value of MSRs at June 27, 2008 and the pre-tax sensitivity of the fair values to an immediate 10% and 20% adverse change in these assumptions:
 
         
(dollars in millions)
 
 
Fair value of capitalized MSRs
  $ 333  
Weighted average prepayment speed (CPR)
    22.3 %
Impact on fair value of 10% adverse change
  $ (20 )
Impact on fair value of 20% adverse change
  $ (42 )
Weighted average discount rate
    17.5 %
Impact on fair value of 10% adverse change
  $ (13 )
Impact on fair value of 20% adverse change
  $ (26 )
 
The sensitivity analysis above is hypothetical and should be used with caution. In particular, the effect of a variation in a particular assumption on the fair value of MSRs is calculated independent of changes in any other assumption; in practice, changes in one factor may result in changes in another factor, which may magnify or counteract the sensitivities. Further changes in fair value based on a single variation in assumptions generally cannot be extrapolated because the relationship of the change in a single assumption to the change in fair value may not be linear.
 
Variable Interest Entities
 
FIN 46R requires an entity to consolidate a VIE if that enterprise has a variable interest that will absorb a majority of the variability of the VIE’s expected losses, receive a majority of the variability of the VIE’s expected residual returns, or both. The entity required to consolidate a VIE is known as the primary beneficiary. A QSPE is a type of VIE that holds financial instruments and distributes cash flows to investors based on preset terms. QSPEs are commonly used in mortgage and other securitization transactions. In accordance with SFAS No. 140 and FIN 46R, Merrill Lynch typically does not consolidate QSPEs. Information regarding QSPEs can be found in the Securitization section of this Note and the Guarantees section in Note 11 to the Condensed Consolidated Financial Statements.
 
Where an entity is a significant variable interest holder, FIN 46R requires that entity to disclose its maximum exposure to loss as a result of its interest in the VIE. It should be noted that this measure does not reflect Merrill Lynch’s estimate of the actual losses that could result from adverse changes because it does not reflect the economic hedges Merrill Lynch enters into to reduce its exposure.


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The following tables summarize Merrill Lynch’s involvement with certain VIEs as of June 27, 2008 and December 28, 2007, respectively. The table below does not include information on QSPEs or those VIEs where Merrill Lynch is the primary beneficiary and holds a majority of the voting interests in the entity.
 
                                 
(dollars in millions)
 
       
Significant Variable
    Primary Beneficiary   Interest Holder
     
    Net
  Recourse
  Total
   
    Asset
  to Merrill
  Asset
  Maximum
    Size(4)   Lynch(5)   Size(6)   Exposure
 
June 27, 2008
                               
Loan and real estate VIEs
  $ 6,945     $ 6,051     $ -     $ -  
Guaranteed and other funds(1)
    1,667       162       324       171  
Credit-linked note and other VIEs(2)
    138       265       -       -  
Tax planning VIEs(3)
    1       3,473       152       5  
 
 
December 28, 2007
                               
Loan and real estate VIEs
  $ 15,420     $ -     $ 307     $ 232  
Guaranteed and other funds(1)
    4,655       928       246       23  
Credit-linked note and other VIEs(2)
    83       -       5,438       9,081  
Tax planning VIEs(3)
    1       -       483       15  
 
 
(1) The maximum exposure for guaranteed and other funds is the fair value of Merrill Lynch’s investments, derivatives entered into with the VIEs if they are in an asset position, and liquidity and credit facilities with certain VIEs.
(2) The maximum exposure for credit-linked note and other VIEs is the notional amount of total return swaps that Merrill Lynch has entered into with the VIEs. This assumes a total loss on the referenced assets underlying the total return swaps. The maximum exposure may be different than the total asset size due to the netting of certain derivatives in the VIE.
(3) The maximum exposure for tax planning VIEs reflects indemnifications made by Merrill Lynch to investors in the VIEs.
(4) This column reflects the size of the assets held in the VIE after accounting for intercompany eliminations and any balance sheet netting of assets and liabilities as permitted by FIN 39.
(5) This column reflects the extent, if any, to which investors have recourse to Merrill Lynch beyond the assets held in the VIE. For certain loan and real estate and tax planning VIEs, recourse to Merrill Lynch represents the notional amount of derivatives that Merrill Lynch has on the assets in the VIEs.
(6) This column reflects the total size of the assets held in the VIE.
 
Merrill Lynch has entered into transactions with a number of VIEs in which it is the primary beneficiary and therefore must consolidate the VIE or is a significant variable interest holder in the VIE. These VIEs are as follows:
 
Loan and Real Estate VIEs
 
  •   Merrill Lynch has investments in VIEs that hold loans or real estate. Merrill Lynch may be either the primary beneficiary which would result in consolidation of the VIE, or may be a significant variable interest holder. These VIEs include entities that are primarily designed to provide financing to clients, to invest in real estate or obtain exposure to mortgage related assets. These VIEs include securitization vehicles that Merrill Lynch is required to consolidate because QSPE status has not been met and Merrill Lynch is the primary beneficiary as it retains the residual interests. This was a result of Merrill Lynch’s inability to sell mortgage related securities because of the illiquidity in the securitization markets. Merrill Lynch’s inability to sell certain securities disqualified the VIEs as QSPEs thereby resulting in Merrill Lynch’s consolidation of the VIEs. Depending upon the continued illiquidity in the securitization market, these transactions and future transactions that could fail QSPE status


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  may require consolidation and related disclosures. Merrill Lynch also is the primary beneficiary for certain VIEs as a result of total return swaps over the assets (primarily mortgage related) in the VIE.
 
For consolidated VIEs that hold loans or mortgage related assets, the assets of the VIEs are recorded in trading assets-mortgages, mortgage-backed and asset-backed, other assets, or loans, notes, and mortgages in the Condensed Consolidated Balance Sheets. For consolidated VIEs that hold real estate investments, these real estate investments are included in other assets in the Condensed Consolidated Balance Sheets. In certain instances, the beneficial interest holders in these VIEs have no recourse to the general credit of Merrill Lynch; their investments are paid exclusively from the assets in the VIE. However, investors have recourse to Merrill Lynch in instances where Merrill Lynch retains all the exposure to the assets in the VIE through total return swaps. These transactions resulted in an increase in recourse to Merrill Lynch at June 27, 2008 as compared to year end 2007. The net assets of loan and real estate VIEs decreased as Merrill Lynch sold mortgage-related securities, resulting in the associated VIEs qualifying as QSPEs; therefore, Merrill Lynch no longer consolidates these securitization vehicles.
 
Guaranteed and Other Funds
 
  •   Merrill Lynch is the sponsor of funds that provide a guaranteed return to investors at the maturity of the VIE. This guarantee may include a guarantee of the return of an initial investment or of the initial investment plus an agreed upon return depending on the terms of the VIE. Investors in certain of these VIEs have recourse to Merrill Lynch to the extent that the value of the assets held by the VIEs at maturity is less than the guaranteed amount. In some instances, Merrill Lynch is the primary beneficiary and must consolidate the fund. Assets held in these VIEs are primarily classified in trading assets. In instances where Merrill Lynch is not the primary beneficiary, the guarantees related to these funds are further discussed in Note 11 to the Condensed Consolidated Financial Statements.
 
  •   Merrill Lynch has made certain investments in alternative investment fund structures that are VIEs. Merrill Lynch is the primary beneficiary of these funds as a result of its substantial investment in the vehicles. Merrill Lynch records the assets in these VIEs in investment securities in the Condensed Consolidated Balance Sheets.
 
  •   Merrill Lynch has established two asset-backed commercial paper conduits (“Conduits”), one of which remains active. Merrill Lynch’s variable interests in the active Conduit are in the form of 1) a liquidity facility that protects commercial paper holders against short term changes in the fair value of the assets held by the Conduit in the event of a disruption in the commercial paper market, and 2) a credit facility to the Conduit that protects commercial paper investors against credit losses for up to a certain percentage of the portfolio of assets held by the Conduit. Merrill Lynch also provided a liquidity facility with a third Conduit that it did not establish and Merrill Lynch had purchased all the assets from this Conduit at December 28, 2007.
 
At June 27, 2008, Merrill Lynch had liquidity and credit facilities outstanding or maximum exposure to loss with the active Conduit for $924 million. The maximum exposure to loss assumes a total loss on the assets in the Conduit. The underlying assets in the Conduit are primarily auto and equipment loans and lease receivables totaling $523 million. The Conduit also has unfunded loan commitments for $343 million. This Conduit remained active and continued to issue commercial paper, although during the latter half of 2007 there were instances when it was required to draw on its liquidity facility with Merrill Lynch. Merrill


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Lynch had purchased loans and asset backed securities under these facilities of $1.4 billion in 2007. The facilities were not drawn upon and Merrill Lynch did not purchase any assets in the second quarter of 2008. Merrill Lynch carries these assets as investment securities — available-for-sale. Merrill Lynch also periodically purchases commercial paper issued by this Conduit and held $81 million of commercial paper at June 27, 2008. These purchases resulted in reconsideration events under FIN 46R that required Merrill Lynch to reassess whether it must consolidate the Conduit.
 
As of the last reconsideration event, Merrill Lynch concluded it was not the primary beneficiary and does not hold a significant variable interest at June 27, 2008 and it was not the primary beneficiary and did not have a significant variable interest in this Conduit at year-end 2007. In July 2008, this Conduit became inactive as Merrill Lynch purchased the remaining assets. Merrill Lynch does not intend to utilize this Conduit in the future.
 
The liquidity and credit facilities are further discussed in Note 11.
 
Credit-Linked Note and Other VIEs
 
  •   Merrill Lynch has entered into transactions with VIEs where Merrill Lynch typically purchases credit protection from the VIE in the form of a derivative in order to synthetically expose investors to a specific credit risk. These are commonly known as credit-linked note VIEs. Merrill Lynch also takes synthetic exposure to the underlying investment grade collateral held in these VIEs, which primarily includes super senior U.S. sub-prime ABS CDOs, through total return swaps. As a result of a reconsideration event during the first quarter of 2008, Merrill Lynch’s exposure to these vehicles declined such that at June 27, 2008, Merrill Lynch no longer held a significant variable interest in these vehicles. The decrease in Total Asset Size and Maximum Exposure as compared to year end 2007 is due to Merrill Lynch no longer holding a significant variable interest in these vehicles. Merrill Lynch recorded its transactions with these VIEs as trading assets/liabilities-derivative contracts in the Condensed Consolidated Financial Statements.
 
  •   In 2004, Merrill Lynch entered into a transaction with a VIE whereby Merrill Lynch arranged for additional protection for directors and employees to indemnify them against certain losses that they may incur as a result of claims against them. Merrill Lynch is the primary beneficiary and consolidates the VIE because its employees benefit from the indemnification arrangement. As of June 27, 2008 and December 28, 2007 the assets of the VIE totaled approximately $16 million, representing a purchased credit default agreement, which is recorded in other assets on the Condensed Consolidated Balance Sheets. In the event of a Merrill Lynch insolvency, proceeds of $140 million will be received by the VIE to fund any claims. Neither Merrill Lynch nor its creditors have any recourse to the assets of the VIE.
 
Tax Planning VIEs
 
  •   Merrill Lynch has entered into transactions with VIEs that are used, in part, to provide tax planning strategies to investors and/or Merrill Lynch through an enhanced yield investment security. These structures typically provide financing to Merrill Lynch and/or the investor at enhanced rates. Merrill Lynch may be either the primary beneficiary of and consolidate the VIE, or may be a significant variable interest holder in the VIE. Recourse increased during the period as a result of new transactions where Merrill Lynch consolidated the VIEs and investors have recourse to Merrill Lynch through derivatives entered into either directly with Merrill Lynch or through the VIE.


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Note 7.  Loans, Notes, Mortgages and Related Commitments to Extend Credit
 
Loans, notes, mortgages and related commitments to extend credit include:
 
  •   Consumer loans, which are substantially secured, including residential mortgages, home equity loans, and other loans to individuals for household, family, or other personal expenditures.
 
  •   Commercial loans including corporate and institutional loans (including corporate and financial sponsor, non-investment grade lending commitments), commercial mortgages, asset-based loans, small- and middle-market business loans, and other loans to businesses.
 
Loans, notes, mortgages and related commitments to extend credit at June 27, 2008 and December 28, 2007, are presented below. This disclosure includes commitments to extend credit that, if drawn upon, will result in loans held for investment or loans held for sale.
 
                                 
(dollars in millions)
 
    Loans   Commitments(1)
     
    June 27,
  Dec. 28,
  June 27,
  Dec. 28,
    2008   2007   2008(2)(3)   2007(3)
 
 
Consumer:
                               
Mortgages
  $ 31,122     $ 26,939     $ 10,064     $ 7,023  
Other
    1,816       5,392       1,347       3,298  
Commercial and small- and middle-market business:
                               
Investment grade
    17,548       18,917       33,532       36,921  
Non-investment grade
    29,286       44,277       14,286       30,990  
                                 
      79,772       95,525       59,229       78,232  
Allowance for loan losses
    (602 )     (533 )     -       -  
Reserve for lending-related commitments
    -       -       (1,594 )     (1,408 )
                                 
Total, net
  $ 79,170     $ 94,992     $ 57,635     $ 76,824  
(1) Commitments are outstanding as of the date the commitment letter is issued and are comprised of closed and contingent commitments. Closed commitments represent the unfunded portion of existing commitments available for draw down. Contingent commitments are contingent on the borrower fulfilling certain conditions or upon a particular event, such as an acquisition. A portion of these contingent commitments may be syndicated among other lenders or replaced with capital markets funding.
(2) See Note 11 to the Condensed Consolidated Financial Statements for a maturity profile of these commitments.
(3) In addition to the loan origination commitments included in the table above, at June 27, 2008, Merrill Lynch entered into agreements to purchase $302 million of loans that, upon settlement of the commitment, will be classified in loans held for investment and loans held for sale. Similar loan purchase commitments totaled $330 million at December 28, 2007. See Note 11 to the Condensed Consolidated Financial Statements for additional information.


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Activity in the allowance for loan losses is presented below:
 
                 
(dollars in millions)
 
    Six Months Ended
     
    June 27,
  June 29,
    2008   2007
 
 
Allowance for loan losses, at beginning of period
  $ 533     $ 478  
Provision for loan losses
    170       11  
Charge-offs
    (104 )     (43 )
Recoveries
    6       9  
                 
Net charge-offs
    (98 )     (34 )
Other
    (3 )     (20 )
                 
Allowance for loan losses, at end of period
  $ 602     $ 435  
 
Consumer loans, which are substantially secured, consisted of approximately 221,500 individual loans at June 27, 2008. Commercial loans consisted of approximately 14,800 separate loans. The principal balance of non-accrual loans was $585 million at June 27, 2008 and $607 million at December 28, 2007. The investment grade and non-investment grade categorization is determined using the credit rating agency equivalent of internal credit ratings. Non-investment grade counterparties are those rated lower than the BBB− category. In some cases Merrill Lynch enters into single name and index credit default swaps to mitigate credit exposure related to funded and unfunded commercial loans. The notional value of these swaps totaled $14.1 billion and $16.1 billion at June 27, 2008 and December 28, 2007, respectively. For information on credit risk management see Note 3 of the 2007 Annual Report.
 
The above amounts include $24.7 billion and $49.0 billion of loans held for sale at June 27, 2008 and December 28, 2007, respectively. Loans held for sale are loans that management expects to sell prior to maturity. At June 27, 2008, such loans consisted of $8.9 billion of consumer loans, primarily residential mortgages and automobile loans, and $15.8 billion of commercial loans, approximately 12% of which are to investment grade counterparties. At December 28, 2007, such loans consisted of $11.6 billion of consumer loans, primarily residential mortgages and automobile loans, and $37.4 billion of commercial loans, approximately 19% of which were to investment grade counterparties.
 
Note 8.  Goodwill and Intangibles
 
Goodwill
 
Goodwill is the cost of an acquired company in excess of the fair value of identifiable net assets at acquisition date. Goodwill is tested annually (or more frequently under certain conditions) for impairment at the reporting unit level in accordance with SFAS No. 142, Goodwill and Other Intangible Assets.


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The following table sets forth the changes in the carrying amount of Merrill Lynch’s goodwill by business segment for the six months ended June 27, 2008:
 
                         
(dollars in millions)    
 
    GMI   GWM   Total
 
 
Goodwill:
                       
December 28, 2007
  $ 2,970     $ 1,620     $ 4,590  
Translation adjustment and other
    24       2       26  
                         
June 27, 2008
  $ 2,994     $ 1,622     $ 4,616  
 
 
 
Intangible Assets
 
Intangible assets at June 27, 2008 and December 28, 2007 consist primarily of value assigned to customer relationships and core deposits. Intangible assets with definite lives are tested for impairment in accordance with SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets, (“SFAS No. 144”) whenever certain conditions exist which would indicate the carrying amounts of such assets may not be recoverable. Intangible assets with definite lives are amortized over their respective estimated useful lives.
 
The gross carrying amounts of intangible assets were $633 million and $644 million as of June 27, 2008 and December 28, 2007, respectively. Accumulated amortization of other intangible assets amounted to $191 million and $143 million at June 27, 2008 and December 28, 2007, respectively.
 
Amortization expense for the three and six months ended June 27, 2008 was $29 million and $53 million, respectively. Amortization expense for the three and six months ended June 29, 2007 was $22 million and $43 million, respectively.
 
Note 9.  Borrowings and Deposits
 
ML & Co. is the primary issuer of all of Merrill Lynch’s debt instruments. For local tax or regulatory reasons, debt is also issued by certain subsidiaries.
 
The value of Merrill Lynch’s debt instruments as recorded on the Condensed Consolidated Balance Sheets does not necessarily represent the amount that will be repaid at maturity. This is due to the following:
 
  •   Certain debt issuances are issued at a discount to their redemption amount, which will accrete up to the redemption amount as they approach maturity;
 
  •   Certain debt issuances are accounted for at fair value and incorporate changes in Merrill Lynch’s creditworthiness as well as other underlying risks (see Note 3);
 
  •   Certain structured notes whose coupon or repayment terms are linked to the performance of debt and equity securities, indices, currencies or commodities will take into consideration the fair value of those risks; and
 
  •   Certain debt issuances are adjusted for the impact of the application of fair value hedge accounting (see Note 1).


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Total borrowings at June 27, 2008 and December 28, 2007, which are comprised of short-term borrowings, long-term borrowings and junior subordinated notes (related to trust preferred securities), consisted of the following:
 
                 
(dollars in millions)
 
    June 27,
  Dec. 28,
    2008   2007
 
Senior debt issued by ML & Co. 
  $ 159,573     $ 148,190  
Senior debt issued by subsidiaries — guaranteed by ML & Co. 
    11,906       14,878  
Senior structured notes issued by ML & Co. 
    43,341       45,133  
Senior structured notes issued by subsidiaries — guaranteed by ML & Co. 
    42,931       31,401  
Subordinated debt issued by ML & Co. 
    12,944       10,887  
Junior subordinated notes (related to trust preferred securities)
    5,193       5,154  
Other subsidiary financing — not guaranteed by ML & Co. 
    12,628       5,597  
Other subsidiary financing — non-recourse(1)
    6,252       29,801  
                 
Total
  $ 294,768     $ 291,041  
 
 
(1) Other subsidiary financing — non-recourse is primarily attributable to debt issued to third parties by consolidated entities that are VIEs. Additional information regarding VIEs is provided in Note 6 to the Condensed Consolidated Financial Statements.
 
Borrowings and deposits at June 27, 2008 and December 28, 2007, are presented below:
 
                 
(dollars in millions)
 
    June 27,
  Dec. 28,
    2008   2007
 
 
Short-term borrowings
               
Commercial paper
  $ 8,620     $ 12,908  
Promissory notes
    -       2,750  
Secured short-term borrowings
    1,656       4,851  
Other unsecured short-term borrowings
    8,863       4,405  
                 
Total
  $ 19,139     $ 24,914  
                 
Long-term borrowings(1)
               
Fixed-rate obligations(2)
  $ 117,161     $ 102,020  
Variable-rate obligations(3)(4)
    151,520       156,743  
Zero-coupon contingent convertible debt (LYONs®)
    1,599       2,210  
Other Zero-coupon obligations
    156       -  
                 
Total
  $ 270,436     $ 260,973  
                 
Deposits
               
U.S.
  $ 72,065     $ 76,634  
Non U.S.
    28,393       27,353  
                 
Total
  $ 100,458     $ 103,987  
 
 
(1) Excludes junior subordinated notes (related to trust preferred securities).
(2) Fixed-rate obligations are generally swapped to floating rates.
(3) Variable interest rates are generally based on rates such as LIBOR, the U.S. Treasury Bill Rate, or the Federal Funds Rate.
(4) Included are various equity-linked, credit-linked or other indexed instruments.


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At June 27, 2008, long-term borrowings mature as follows:
 
                     
(dollars in millions)    
 
 
Less than 1 year
  $ 79,159       29 %    
1 - 2 years
    34,053       13      
2+ - 3 years
    20,772       8      
3+ - 4 years
    26,611       10      
4+ - 5 years
    21,808       8      
Greater than 5 years
    88,033       32      
                     
Total
  $ 270,436       100 %    
 
 
 
Certain long-term borrowing agreements contain provisions whereby the borrowings are redeemable at the option of the holder (“put” options) at specified dates prior to maturity. These borrowings are reflected in the above table as maturing at their put dates, rather than their contractual maturities. Management believes, however, that a portion of such borrowings will remain outstanding beyond their earliest redemption date.
 
A limited number of notes whose coupon or repayment terms are linked to the performance of debt and equity securities, indices, currencies or commodities maturities may be accelerated based on the value of a referenced index or security, in which case Merrill Lynch may be required to immediately settle the obligation for cash or other securities. These notes are included in the portion of long-term debt maturing in less than a year.
 
Except for the $1.6 billion of aggregate principal amount of floating rate zero-coupon contingently convertible liquid yield option notes (“LYONs®”) that were outstanding at June 27, 2008, senior and subordinated debt obligations issued by ML & Co. and senior debt issued by subsidiaries and guaranteed by ML & Co. do not contain provisions that could, upon an adverse change in ML & Co.’s credit rating, financial ratios, earnings, cash flows, or stock price, trigger a requirement for an early payment, additional collateral support, changes in terms, acceleration of maturity, or the creation of an additional financial obligation.
 
On March 13, 2008, approximately $0.6 billion of LYONs® were submitted to Merrill Lynch for repurchase at an accreted price of $1,089.05, resulting in no gain or loss to Merrill Lynch. Following the repurchase, $1.6 billion of LYONs® remain outstanding. Merrill Lynch amended the terms of its outstanding LYONs® in March 2008 to include the following:
 
  •   An increase in the number of shares into which the LYONs® convert from 14.0915 shares to 16.5 shares,
 
  •   An extension of the call protection in the LYONs®, which would otherwise have terminated on March 13, 2008, thru March 13, 2014,
 
  •   The inclusion of two additional dates, September 13, 2010 and March 13, 2014, on which investors can require Merrill Lynch to repurchase the LYONs®.
 
The modified conversion price (and the accreted conversion price) for LYONs® as of March 28, 2008 is $66. Shares will not be included in diluted earnings per share until Merrill Lynch’s share price exceeds the accreted conversion price. All other features of the LYONs® remain unchanged (see Note 9 of Merrill Lynch’s 2007 Annual Report for further information). In accordance with EITF Issue No. 06-6, Debtor’s Accounting for Modification (or Exchange) of Convertible Debt Instruments, the change to the terms of Merrill Lynch’s outstanding LYONs® resulted in a debt extinguishment and a new issuance of long-term borrowings in the first quarter of 2008. The amount of the loss on the debt


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extinguishment was not material to Merrill Lynch’s Condensed Consolidated Statements of (Loss)/Earnings.
 
The effective weighted-average interest rates for borrowings at June 27, 2008 and December 28, 2007 (excluding structured notes) were as follows:
 
                 
 
    June 27,
  Dec. 28,
    2008   2007
 
Short-term borrowings
    3.36 %     4.64 %
Long-term borrowings
    4.57       4.35  
Junior subordinated notes (related to trust preferred securities)
    6.82       6.91  
 
 
 
See Note 9 of the 2007 Annual Report for additional information on Borrowings.
 
Merrill Lynch also obtains standby letters of credit from issuing banks to satisfy various counterparty collateral requirements, in lieu of depositing cash or securities collateral. Such standby letters of credit aggregated $5.6 billion and $5.8 billion at June 27, 2008 and December 28, 2007, respectively.
 
Note 10.  Stockholders’ Equity and Earnings Per Share
 
Preferred Stock Issuance
 
On April 29, 2008, Merrill Lynch issued $2.7 billion of new perpetual 8.625% Non-Cumulative Preferred Stock, Series 8.
 
Mandatory Convertible Preferred Stock Issuance
 
On various dates in January and February 2008, Merrill Lynch issued an aggregate of 66,000 shares of newly issued 9% Non-Voting Mandatory Convertible Non-Cumulative Preferred Stock (the “convertible preferred stock”), Series 1, par value $1.00 per share and liquidation preference $100,000 per share, to several long-term investors at a price of $100,000 per share, for an aggregate purchase price of approximately $6.6 billion. If not converted earlier, the convertible preferred stock will automatically convert into Merrill Lynch common stock on October 15, 2010, based on the 20 consecutive trading day volume weighted average price of Merrill Lynch common stock ending the day immediately preceding the mandatory conversion date (“the current stock price”). If Merrill Lynch’s current stock price at the mandatory conversion date is greater than or equal to the initial threshold appreciation price of $61.30, a holder will receive 1,631 common shares for each share of convertible preferred stock. If Merrill Lynch’s current stock price at the mandatory conversion date is less than or equal to the initial minimum conversion price of $52.40, a holder will receive 1,908 shares of common stock for each share of convertible preferred stock. If Merrill Lynch’s current stock price at the mandatory conversion date is less than $61.30 but greater than $52.40, a holder will receive a variable number of shares equal to the value of its initial investment. The conversion rates are subject to certain anti-dilution provisions. Holders may elect to convert anytime prior to October 15, 2010 into 1,631 common shares, which represents the minimum number of shares permitted under the conversion formula. In addition, Merrill Lynch has the ability to force conversion in the event that the convertible preferred stock no longer qualifies as Tier 1 capital for regulatory purposes. Upon a forced conversion, a holder will receive 1,908 shares, which represents the maximum number of shares permitted under the conversion formula. Upon a forced conversion, Merrill Lynch will also pay to the holder of the convertible preferred stock an amount equal to the present value of the remaining fixed dividend payments through and including the original mandatory conversion date. Dividends on the convertible


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preferred stock, if and when declared, are payable in cash on a quarterly basis in arrears on February 28, May 28, August 28 and November 28 of each year through the mandatory conversion date. Merrill Lynch may not declare dividends to its common stockholders unless dividends have been declared on the convertible preferred stock.
 
The convertible preferred stock also contains a reset feature which may result in an adjustment to the conversion formula. In the case that Merrill Lynch receives aggregate gross proceeds of greater than $1 billion related to the issuance of its stock, or securities convertible into its common stock (subject to certain exclusions), between January 15, 2008 and January 15, 2009, at a price less than the initial minimum conversion price of $52.40, the initial minimum conversion price of $52.40 and the initial threshold appreciation price of $61.30 will adjust, resulting in the holder receiving more shares than that stated above.
 
The convertible preferred stock is reported in Preferred Stockholders’ Equity in the Condensed Consolidated Balance Sheet.
 
On July 28, 2008, Merrill Lynch announced initiatives to enhance its capital position, which included the conversion of a portion of the outstanding convertible preferred stock into common stock. The reset feature for all securities exchanged has been eliminated. Refer to Note 18 for further details.
 
Common Stock Issuance
 
On December 24, 2007, Merrill Lynch reached agreements with each of Temasek Capital (Private) Limited (“Temasek”) and Davis Selected Advisors LP (“Davis”) to sell an aggregate of 116.7 million shares of newly issued common stock, par value $1.331/3 per share, at $48.00 per share, for an aggregate purchase price of approximately $5.6 billion.
 
Davis purchased 25 million shares of Merrill Lynch common stock on December 27, 2007 at a price per share of $48.00, or an aggregate purchase price of $1.2 billion. Temasek purchased 55 million shares on December 28, 2007 and the remaining 36.7 million shares on January 11, 2008 for an aggregate purchase price of $4.4 billion. In addition, Merrill Lynch granted Temasek an option to purchase an additional 12.5 million shares of common stock under certain circumstances. This option was exercised, with 2.8 million shares issued on February 1, 2008 and 9.7 million shares issued on February 5, 2008, in each case at a purchase price of $48.00 per share for an aggregate purchase price of $600 million.
 
In connection with the Temasek transaction, if Merrill Lynch sells or agrees to sell any common stock (or equity securities convertible into common stock) within one year of closing at a purchase, conversion or reference price per share less than $48.00, then it must make a payment to Temasek to compensate Temasek for the aggregate excess amount per share paid by Temasek, which is settled in cash or common stock at Merrill Lynch’s option.
 
On July 28, 2008, Merrill Lynch announced initiatives to enhance its capital position, which included the issuance of common stock through a public offering. This public offering has established an obligation for Merrill Lynch under the reset provisions contained in its agreement with Temasek. Refer to Note 18 for further details.


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Earnings Per Share
 
Basic EPS is calculated by dividing earnings available to common stockholders by the weighted-average number of common shares outstanding. Diluted EPS is similar to basic EPS, but adjusts for the effect of the potential issuance of common shares. The following table presents the computations of basic and diluted EPS:
 
                                 
(dollars in millions, except per share amounts)
 
    Three Months Ended   Six Months Ended
     
    June 27,
  June 29,
  June 27,
  June 29,
    2008   2007   2008   2007
 
Net (loss)/earnings from continuing operations
  $ (4,634 )   $ 2,010     $ (6,603 )   $ 4,040  
Net (loss)/earnings from discontinued operations
    (20 )     129       (13 )     257  
Preferred stock dividends
    (237 )     (72 )     (411 )     (124 )
                                 
Net (loss)/earnings applicable to common shareholders — for basic and diluted EPS(1)
  $ (4,891 )   $ 2,067     $ (7,027 )   $ 4,173  
                                 
 
 
                                 
(shares in thousands)
                               
Weighted-average basic shares outstanding(2)(8)
    984,091       833,804       978,463       837,551  
Effect of dilutive instruments:
                               
Employee stock options(3)
    -       39,712       -       40,829  
FACAAP shares(3)
    -       20,736       -       20,483  
Restricted shares and units(3)
    -       24,424       -       23,084  
Convertible LYONs®(4)
    -       4,645       -       4,819  
ESPP shares(3)
    -       9       -       12  
                                 
Dilutive potential common shares
    -       89,526       -       89,227  
                                 
Diluted Shares(5)(6)(8)
    984,091       923,330       978,463       926,778  
 
 
Basic EPS from continuing operations
  $ (4.95 )   $ 2.32     $ (7.17 )   $ 4.67  
Basic EPS from discontinued operations
    (0.02 )     0.16       (0.01 )     0.31  
                                 
Basic EPS
  $ (4.97 )   $ 2.48     $ (7.18 )   $ 4.98  
                                 
Diluted EPS from continuing operations
  $ (4.95 )   $ 2.10     $ (7.17 )   $ 4.22  
Diluted EPS from discontinued operations
    (0.02 )     0.14       (0.01 )     0.28  
                                 
Diluted EPS
  $ (4.97 )   $ 2.24     $ (7.18 )   $ 4.50  
                                 
Common shares outstanding at period end(7)(8)
    985,376       862,559       985,376       862,559  
 
 
(1) Due to the net loss for the three and six months ended June 27, 2008, inclusion of the incremental shares on the Mandatory Convertible Preferred Stock would be antidilutive and have not been included as part of the Diluted EPS calculation. See Mandatory Convertible Preferred Stock Issuance section above for additional information.
(2) Includes shares exchangeable into common stock.
(3) See Note 13 of the 2007 Annual Report for a description of these instruments.
(4) See Note 9 to the Condensed Consolidated Financial Statements and Note 9 of the 2007 Annual Report for additional information on LYONs®.
(5) Excludes 243 thousand of instruments for the three and six month periods ended June 29, 2007 and 281 thousand for the six months ended June 29, 2007 that were considered antidilutive and thus were not included in the above calculations.
(6) Due to the net loss for the three and six months ended June 27, 2008, the Diluted EPS calculation excludes 126 million of incremental shares related to the mandatory convertible preferred stock, 122 million of employee stock options, 40 million of FACAAP shares, 45 million of restricted shares and units, and 311 thousand of ESPP shares, as they were antidilutive.
(7) Increase in outstanding shares primarily related to Temasek and Davis issuances.
(8) Subsequent to the end of the second quarter of 2008, Merrill Lynch issued common stock through a public offering. Refer to Note 18 for further details.


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Note 11.  Commitments, Contingencies and Guarantees
 
Litigation
 
Merrill Lynch has been named as a defendant in various legal actions, including arbitrations, class actions, and other litigation arising in connection with its activities as a global diversified financial services institution.
 
Some of the legal actions include claims for substantial compensatory and/or punitive damages or claims for indeterminate amounts of damages. In some cases, the issuers that would otherwise be the primary defendants in such cases are bankrupt or otherwise in financial distress. Merrill Lynch is also involved in investigations and/or proceedings by governmental and self-regulatory agencies.
 
Merrill Lynch believes it has strong defenses to, and where appropriate, will vigorously contest, many of these matters. Given the number of these matters, some are likely to result in adverse judgments, penalties, injunctions, fines, or other relief. Merrill Lynch may explore potential settlements before a case is taken through trial because of the uncertainty, risks, and costs inherent in the litigation process. In accordance with SFAS No. 5, Accounting for Contingencies, Merrill Lynch will accrue a liability when it is probable of being incurred and the amount of the loss can be reasonably estimated. In many lawsuits and arbitrations, including almost all of the class action lawsuits, it is not possible to determine whether a liability has been incurred or to estimate the ultimate or minimum amount of that liability until the case is close to resolution, in which case no accrual is made until that time. In view of the inherent difficulty of predicting the outcome of such matters, particularly in cases in which claimants seek substantial or indeterminate damages, Merrill Lynch cannot predict or estimate what the eventual loss or range of loss related to such matters will be. Merrill Lynch continues to assess these cases and believes, based on information available to it, that the resolution of these matters will not have a material adverse effect on the financial condition of Merrill Lynch as set forth in the Condensed Consolidated Financial Statements, but may be material to Merrill Lynch’s operating results or cash flows for any particular period and may impact ML & Co.’s credit ratings.
 
Commitments
 
At June 27, 2008, Merrill Lynch’s commitments had the following expirations:
 
                                         
(dollars in millions)
 
        Commitment expiration
        Less than
           
    Total   1 year   1 - 3 years   3+- 5 years   Over 5 years
 
 
Commitments to extend credit
  $ 59,229     $ 18,535     $ 11,525     $ 21,454     $ 7,715  
Purchasing and other commitments
    9,181       2,819       1,058       1,391       3,913  
Operating leases
    4,096       674       1,270       1,003       1,149  
Commitments to enter into forward dated resale and securities borrowing agreements
    64,790       64,614       176       -       -  
Commitments to enter into forward dated repurchase and securities lending agreements
    76,529       76,365       164       -       -  
 
 


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Commitments to Extend Credit
 
Merrill Lynch primarily enters into commitments to extend credit, predominantly at variable interest rates, in connection with corporate finance, corporate and institutional transactions and asset-based lending transactions. Clients may also be extended loans or lines of credit collateralized by first and second mortgages on real estate, certain liquid assets of small businesses, or securities. These commitments usually have a fixed expiration date and are contingent on certain contractual conditions that may require payment of a fee by the counterparty. Once commitments are drawn upon, Merrill Lynch may require the counterparty to post collateral depending upon creditworthiness and general market conditions. See Note 7 for additional information.
 
The contractual amounts of these commitments represent the amounts at risk should the contract be fully drawn upon, the client defaults, and the value of the existing collateral becomes worthless. The total amount of outstanding commitments may not represent future cash requirements, as commitments may expire without being drawn upon.
 
For lending commitments where the loan will be classified as held for sale upon funding, liabilities associated with unfunded commitments are calculated at the lower of cost or fair value, capturing declines in the fair value of the respective credit risk. For loan commitments where the loan will be classified as held for investment upon funding, liabilities are calculated considering both market and historical loss rates. Loan commitments held by entities that apply broker-dealer industry level accounting are accounted for at fair value.
 
Purchasing and Other Commitments
 
In the normal course of business, Merrill Lynch enters into institutional and margin-lending transactions, some of which are on a committed basis, but most of which are not. Margin lending on a committed basis only includes amounts where Merrill Lynch has a binding commitment. These binding margin lending commitments totaled $937 million at June 27, 2008 and $693 million at December 28, 2007.
 
Merrill Lynch had commitments to purchase partnership interests, primarily related to private equity and principal investing activities, of $2.7 billion and $3.1 billion at June 27, 2008 and December 28, 2007, respectively. Merrill Lynch also has entered into agreements with providers of market data, communications, systems consulting, and other office-related services. At June 27, 2008 and December 28, 2007, minimum fee commitments over the remaining life of these agreements totalled $482 million and $453 million, respectively. Merrill Lynch entered into commitments to purchase loans of $4.3 billion (which upon settlement of the commitment will be included in trading assets, loans held for investment or loans held for sale) at June 27, 2008. Such commitments totaled $3.0 billion at December 28, 2007. Other purchasing commitments amounted to $0.8 billion and $0.9 billion at June 27, 2008 and December 28, 2007, respectively.
 
In the normal course of business, Merrill Lynch enters into commitments for underwriting transactions. Settlement of these transactions as of June 27, 2008 would not have a material effect on the consolidated financial condition of Merrill Lynch.
 
In connection with trading activities, Merrill Lynch enters into commitments to enter into resale and securities borrowing and also repurchase and securities lending agreements that are primarily secured by collateral.


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Operating Leases
 
Merrill Lynch has entered into various non-cancelable long-term lease agreements for premises that expire through 2024. Merrill Lynch has also entered into various non-cancelable short-term lease agreements, which are primarily commitments of less than one year under equipment leases.
 
Guarantees
 
Merrill Lynch issues various guarantees to counterparties in connection with certain leasing, securitization and other transactions. In addition, Merrill Lynch enters into certain derivative contracts that meet the accounting definition of a guarantee under FASB Interpretation No. 45, Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indebtedness of Others (“FIN 45”). FIN 45 defines guarantees to include derivative contracts that contingently require a guarantor to make payment to a guaranteed party based on changes in an underlying (such as changes in the value of interest rates, security prices, currency rates, commodity prices, indices, etc.), that relate to an asset, liability or equity security of a guaranteed party. Derivatives that meet the FIN 45 definition of guarantees include certain written options and credit default swaps (contracts that require Merrill Lynch to pay the counterparty the par value of a referenced security if that referenced security defaults). Merrill Lynch does not track, for accounting purposes, whether its clients enter into these derivative contracts for speculative or hedging purposes. Accordingly, Merrill Lynch has disclosed information about all credit default swaps and certain types of written options that can potentially be used by clients to protect against changes in an underlying, regardless of how the contracts are used by the client. These guarantees and their maturity at June 27, 2008 are summarized as follows:
 
                                                 
(dollars in millions)
 
    Maximum
                   
    Payout /
  Less than
          Over
  Carrying
    Notional   1 year   1 - 3 years   3+- 5 years   5 years   Value
 
Derivative contracts
  $ 4,152,925     $ 519,662     $ 828,617     $ 1,412,198     $ 1,392,448     $ 234,383  
Liquidity, credit and default facilities
    19,219       16,813       869       1,537       -       165  
Residual value guarantees
    846       68       362       96       320       11  
Standby letters of credit and other guarantees
    46,169       1,758       1,200       927       42,284       621  
 
 
 
Derivative Contracts
 
For certain derivative contracts, such as written interest rate caps and written currency options, the maximum payout could theoretically be unlimited, because, for example, the rise in interest rates or changes in foreign exchange rates could theoretically be unlimited. In addition, Merrill Lynch does not monitor its exposure to derivatives based on the theoretical maximum payout because that measure does not take into consideration the probability of the occurrence. As such, rather than including the maximum payout, the notional value of these contracts has been included to provide information about the magnitude of involvement with these types of contracts. However, it should be noted that the notional value is not a reliable indicator of Merrill Lynch’s exposure to these contracts.
 
Merrill Lynch records all derivative transactions at fair value on its Condensed Consolidated Balance Sheets. As previously noted, Merrill Lynch does not monitor its exposure to derivative contracts in terms of maximum payout. Instead, a risk framework is used to define risk tolerances and establish limits to help to ensure that certain risk-related losses occur within acceptable, predefined limits. Merrill Lynch economically hedges its exposure to these contracts by entering into a variety of offsetting derivative contracts and security positions. See the Derivatives section of Note 1 for further discussion of risk management of derivatives.


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Merrill Lynch also funds selected assets, including CDOs and CLOs, via derivative contracts with third party structures, the majority of which are not consolidated on its balance sheet. Of the total notional amount of these total return swaps, approximately $24 billion is term financed through facilities provided by commercial banks, $21 billion of long term funding is provided by third party special purpose vehicles and $2 billion is financed with asset backed commercial paper conduits. In certain circumstances, Merrill Lynch may be required to purchase these assets, which would not result in additional gain or loss to the Company as such exposure is already reflected in the fair value of the derivative contracts.
 
Liquidity, Credit and Default Facilities
 
The liquidity, credit and default facilities in the above table relate primarily to municipal bond securitization SPEs and Conduits.
 
Merrill Lynch acts as liquidity provider to certain municipal bond securitization SPEs and provides both liquidity and credit default protection to certain other municipal bond securitization SPEs. As of June 27, 2008, the value of the assets held by the SPEs plus any additional collateral pledged to Merrill Lynch exceeded the amount of beneficial interests issued, which provides additional support to Merrill Lynch in the event that the standby facilities are drawn. In certain of these facilities, Merrill Lynch is generally required to provide liquidity support within seven days, while the remainder have third-party liquidity support for between 30 and 364 days before Merrill Lynch is required to provide liquidity. A significant portion of the facilities where Merrill Lynch is required to provide liquidity support within seven days are “net liquidity” facilities where upon draw Merrill Lynch may direct the trustee for the SPE to collapse the SPE trusts and liquidate the municipal bonds, and Merrill Lynch would only be required to fund any difference between par and the sale price of the bonds. “Gross liquidity” facilities require Merrill Lynch to wait up to 30 days before directing the trustee to liquidate the municipal bonds. Beginning in the second half of 2007, Merrill Lynch began reducing facilities that require liquidity in seven days, and the total amount of such facilities was $12.8 billion as of June 27, 2008, down from $40.7 billion as of June 29, 2007. Details of these liquidity and credit default facilities as of June 27, 2008, are illustrated in the table below:
 
                                         
(dollars in millions)
 
    Merrill Lynch Liquidity Facilities Can Be Drawn:   Municipal Bonds to Which
    In 7 Days with
  In 7 Days with
  After Up to
      Merrill Lynch Has Recourse
    “Net Liquidity”   “Gross Liquidity”   364 Days(1)   Total   if Facilities Are Drawn
 
Merrill Lynch provides standby liquidity facilities
  $ 6,750     $ 1,970     $ 3,022     $ 11,742     $ 13,314  
                                         
Merrill Lynch provides standby liquidity facilities and credit default protection
    1,491       2,588       2,039       6,118       6,695  
                                         
Total
  $ 8,241     $ 4,558     $ 5,061     $ 17,860     $ 20,009  
 
 
(1) Initial liquidity support within 7 days is provided by third parties for a maximum of 364 days.
 
In addition, Merrill Lynch, through a U.S. bank subsidiary has either provided or provides liquidity and credit facilities to three Conduits. The assets in these Conduits included loans and asset-backed securities. In the event of a disruption in the commercial paper market, the Conduits may draw upon their liquidity facilities and sell certain assets held by the respective Conduits to Merrill Lynch, thereby protecting commercial paper holders against certain changes in the fair value of the assets held by the Conduits. The credit facilities protect commercial paper investors against credit losses for up to a


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certain percentage of the portfolio of assets held by the respective Conduits at June 27, 2008. Merrill Lynch has remaining exposure to only one of these Conduits as discussed below.
 
The outstanding amount of the facilities, or Merrill Lynch’s maximum exposure, related to this Conduit is approximately $924 million as of June 27, 2008. The assets remaining in the Conduit are primarily auto and equipment loans and lease receivables totaling $523 million (which approximates their fair value) with unfunded loan commitments for $343 million. The facilities were not drawn upon and Merrill Lynch did not purchase any assets from the Conduit in the second quarter of 2008. In addition, Merrill Lynch periodically purchases commercial paper from this Conduit, and held $81 million of the commercial paper as of June 27, 2008. Merrill Lynch is under no obligation to purchase additional commercial paper. These liquidity and credit facilities are recorded off-balance sheet, unless a liability is deemed necessary when a contingent payment is deemed probable and estimable. In July 2008, this Conduit became inactive, as Merrill Lynch purchased the remaining assets. Merrill Lynch does not intend to utilize this Conduit in the future.
 
Refer to Note 6 to the Condensed Consolidated Financial Statements for more information on Conduits.
 
Residual Value Guarantees
 
The amounts in the above table include residual value guarantees associated with the Hopewell, NJ campus and aircraft leases of $322 million at June 27, 2008.
 
Stand-by Letters of Credit and Other Guarantees
 
Merrill Lynch provides guarantees to counterparties in the form of standby letters of credit in the amount of $2.4 billion. At June 27, 2008, Merrill Lynch held marketable securities of $512 million as collateral to secure these guarantees and a liability of $45 million was recorded on the Condensed Consolidated Balance Sheets.
 
Further, in conjunction with certain principal-protected mutual funds, Merrill Lynch guarantees the return of the initial principal investment at the termination date of the fund. At June 27, 2008, Merrill Lynch’s maximum potential exposure to loss with respect to these guarantees is $376 million assuming that the funds are invested exclusively in other general investments (i.e., the funds hold no risk-free assets), and that those other general investments suffer a total loss. As such, this measure significantly overstates Merrill Lynch’s exposure or expected loss at June 27, 2008. These transactions met the SFAS No. 133 definition of derivatives and, as such, were carried as a liability with a fair value of approximately $7 million at June 27, 2008.
 
Merrill Lynch also provides indemnifications related to the U.S. tax treatment of certain foreign tax planning transactions. The maximum exposure to loss associated with these transactions at June 27, 2008 is $167 million; however, Merrill Lynch believes that the likelihood of loss with respect to these arrangements is remote, and therefore has not recorded any liabilities in respect of these guarantees.
 
In connection with residential mortgage loan and other securitization transactions, Merrill Lynch typically makes representations and warranties about the underlying assets. If there is a material breach of any such representation or warranty, Merrill Lynch may have an obligation to repurchase assets or indemnify the purchaser against any loss. For residential mortgage loan and other securitizations, the maximum potential amount that could be required to be repurchased is the current outstanding asset balance. Specifically related to First Franklin activities, there is currently approximately $41 billion (including loans serviced by others) of outstanding loans that First Franklin sold in various asset sales


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and securitization transactions where management believes we may have an obligation to repurchase the asset or indemnify the purchaser against the loss if claims are made and it is ultimately determined that there has been a material breach related to such loans. Merrill Lynch has recognized a repurchase reserve liability of approximately $565 million at June 27, 2008 arising from these residential mortgage sales and securitization transactions.
 
See Note 11 of the 2007 Annual Report for additional information on guarantees.
 
Note 12.   Employee Benefit Plans
­ ­
 
Merrill Lynch provides pension and other postretirement benefits to its employees worldwide through defined contribution pension, defined benefit pension, and other postretirement plans. These plans vary based on the country and local practices. Merrill Lynch reserves the right to amend or terminate these plans at any time. Refer to Note 12 of the 2007 Annual Report for a complete discussion of employee benefit plans.
 
Defined Benefit Pension Plans
 
Pension cost for the three and six months ended June 27, 2008 and June 29, 2007, for Merrill Lynch’s defined benefit pension plans, included the following components:
 
                                                 
(dollars in millions)
 
    Three Months Ended
    June 27, 2008   June 29, 2007
     
    U.S.
  Non-U.S.
      U.S.
  Non-U.S.
   
    Plans   Plans   Total   Plans   Plans   Total
 
Service cost
  $ -     $ 7     $ 7     $ -     $ 7     $ 7  
Interest cost
    24       21       45       24       20       44  
Expected return on plan assets
    (29 )     (21 )     (50 )     (29 )     (20 )     (49 )
Amortization of net (gains)/losses, prior service costs and other
    -       3       3       (1 )     8       7  
                                                 
Total defined benefit pension cost
  $ (5 )   $ 10     $ 5     $ (6 )   $ 15     $ 9  
 
 
 
                                                 
(dollars in millions)
 
    Six Months Ended
    June 27, 2008   June 29, 2007
     
    U.S.
  Non-U.S.
      U.S.
  Non-U.S.
   
    Plans   Plans   Total   Plans   Plans   Total
 
Service cost
  $ -     $ 14     $ 14     $ -     $ 14     $ 14  
Interest cost
    48       43       91       48       40       88  
Expected return on plan assets
    (59 )     (43 )     (102 )     (58 )     (39 )     (97 )
Amortization of net (gains)/losses, prior service costs and other
    -       6       6       (2 )     15       13  
                                                 
Total defined benefit pension cost
  $ (11 )   $ 20     $ 9     $ (12 )   $ 30     $ 18  
 
 
 
Merrill Lynch disclosed in its 2007 Annual Report that it expected to pay $1 million of benefit payments to participants in the U.S. non-qualified pension plan and Merrill Lynch expected to contribute $11 million and $74 million respectively to its U.S. and non-U.S. defined benefit pension


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plans in 2008. Merrill Lynch does not expect contributions to differ significantly from amounts previously disclosed.
 
Postretirement Benefits Other Than Pensions
 
Other postretirement benefit cost for the three and six months ended June 27, 2008 and June 29, 2007, included the following components:
 
                                &nbs