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Merrill Lynch (MER)Stock (Financial Services Industry, Investment Banks Industry)
 Merrill Lynch (NYSE: MER) is distinct among its peers in that it is both a premier investment bank and one the largest wealth management firms in the world, with over $1.6 trillion in client assets and over 15,000 financial advisers. From 2002 to 2006, Merrill achieved record revenues and grew profit margins from 12% in 2002 to 31% in 2006, in part by cutting over 20,000 personnel in 2002 and consistently reducing non-compensation expenses. The other source of Merrill's success has also been its undoing. Under former CEO E. Stanley O'Neal, Merrill began to shoulder more risk by investing its own assets directly in the market, a strategy pursued successfully by Goldman Sachs Group (GS) for years. For a time, this strategy helped Merrill grow earnings. However, by the company's own admission,[1] risk was poorly handled, and Merrill invested aggressively in collateralized debt obligations based on subprime mortgages. Merrill was forced to write down nearly $8 billion in assets in the third quarter of 2007 and $16.7 billion in the fourth quarter, more than any other investment bank. On May 23, 2008, Merrill set up a group to figure out how to get rid of CDOs and other risky assets,[2] which led to the July 28th sale of $30.6 billion of CDOs for 22¢ on the dollar.[3] Acquisitions have played a major role in Merrill's growth over the last five years. The firm uses acquisitions, or inorganic growth, to both enhance its service offerings and gain new clients to which it can market its products and services. Domestically, the firm will be tested as it attempts to integrate the recently acquired First Franklin, a subprime lender, and First Republic, a provider of banking services to extremely wealthy individuals. The current environment will also make finding additional, affordable acquisition targets challenging in the short term.
[edit] History and Corporate OverviewMerrill Lynch was founded in January 1914 by Charles E. Merrill. The firm became a publicly traded company on June 23, 1971. It began by buying shares in small businesses, ranging from movie studios to grocery stores. After its eventual entry into investment banking, Merrill Lynch expanded at a breakneck pace, offering its myriad services to clients in 37 different countries through early 2000. With the burst of the tech bubble in the early 2000s, however, Merrill Lynch scaled back its international operations significantly. The company also reduced its headcount dramatically.
[edit] Revenue SourcesMerrill Lynch generates revenues from two distinct divisions within the company: Global Markets and Investment Banking (GMI) and Global Wealth Management (GWM).
[edit] Growth InitiativesMergers and Acquisitions (the process of acquiring or merging with another company) have played an integral role in Merrill Lynch's growth strategy over the last five years. In 2007, Merrill acquired First Republic Bank. First Republic is a private bank with branches several in major wealth centers in the U.S., including Los Angeles, San Francisco, New York, Connecticut, and Miami. First Republic provides financial services to ultra-high-net-worth individuals, or people with financial assets of over $30 million. The acquisition will allow Merrill Lynch to generate incremental revenue by selling its wealth management products to First Republic's existing client base. Merrill Lynch clients will also benefit from First Republic's enhanced private banking services. Not everyone is thrilled about this acquisition, however, because Merrill paid a 40% premium to First Republic's shareholders. While some contend that this is the price of breaking into the private banking space, it is still unclear as to whether this price may have been too high or not. [edit] Trends and Forces: Profit drivers and risks[edit] Business CyclesMerrill Lynch is highly impacted by both global and US economic conditions. During periods of rapid economic growth, companies typically borrow more money and offer more IPOs , leading to greater demand for Merrill's investment banking services. Also, the stock markets typically move in the same direction as the overall economy. If the market is up, then demand for trading and other capital markets services will likely increase as well. Conversely, if the economy is depressed, demand for Merrill's banking services decreases substantially. [edit] Interest Rates Interest Rates can be thought of as the cost of borrowing money. Though the impact of interest rates spans across the economy, businesses and lenders are particularly sensitive to fluctuations in interest rates. As interest rates increase, businesses are less likely to issue debt or equity given that the price of borrowing has increased. Interest rates have, however, been fairly low since 2004, which has played a significant role in driving business activities. Merrill has benefited from high levels of mergers and acquisitions, underwriting, and IPO activities over the last three years. [edit] Subprime LendingSubprime lending lending refers to the practice of extending credit or loans to borrowers to who fail qualify for prime or market rates due to their less than optimal credit scores. For the past decade, the interest rates associated with subprime mortgages have been about 2% higher than those associated with prime loans; the rationale is that borrowers with lower credit scores carry a higher risk of default and must therefore pay a considerable risk premium. Subprime borrowers can be extremely sensitive to interest rates. As rates rise, these borrowers, many of whom have adjustable-rate mortgages, find themselves unable to meet their debt obligations. In 2006, Merrill Lynch purchased subprime mortgage originator First Franklin, with the expectation that Merrill would be able to package and resell First Franklin's subprime loans in the form of mortgage-backed securities. Rising numbers of defaults in the subprime mortgage market have had a significantly negative impact on Merrill's First Franklin business. Also, demand for securities backed by subprime mortgages has dwindled, limiting Merrill's ability to repackage and sell First Franklin's loans. On top of all of this, Merrill paid $1.3 billion for First Franklin, which many say was a grossly overinflated price, considering the current state of the subprime market. See the Merrill Lynch Bears article for more information on its subprime exposure. [edit] LitigationAs a leading private wealth manager, Merrill is extremely vulnerable to litigation. Disgruntled clients with both real and imagined complaints often file lawsuits against the company on the bases of poor performance or mismanagement. This litigation can be extremely costly in terms of legal fees and settlements, not to mention the negative publicity that lawsuits entail. Merrill Lynch's Global Market and Investment Banking unit is also vulnerable to lawsuits by regulatory authorities such as the Securities and Exchange Commission (SEC). These lawsuits can not only result in legal defense expenses and fines in the millions of dollars but can also damage the firm's reputation. [edit] CompetitionMerrill Lynch ranked 6th in M&A volume for the first nine months of 2007. It is important to note that Merrill's strategy with regards to both underwriting and M&A advisory focuses on profitability rather than volume. In other words, Merrill Lynch does not seek to be the number one underwriter but instead seeks the most profitable deals, regardless of size.
Merrill Lynch is the dominant player in the private wealth management business. It has the largest sales force and is known for providing best-in-industry training to its financial advisers. Its revenue per adviser is among the highest in the industry, at an average of $860,000 annually. This is partly due to Merrill's effective client segmentation strategy, which emphasizes higher-net-worth clients. Under Merrill's policies, each FA is only allowed to serve a limited number of clients; it, therefore, makes sense for them to concentrate their energy on wealthier clients who generate more income. To encourage this practice, the firm instituted a policy of not paying FAs on relationships under $100K. Merrill lags behind its competitors, however, in terms of its annuitized assets to total assets ratio. Financial advisers generate revenue from annuitized assets by charging a fee equal to a percentage of the client's total assets under management, typically 1% to 3%. The arrangement produces a more stable revenue stream since advisers are paid the same amount regardless of the number of transactions requested by their clients.
 Merrill Lynch2004 Data 2005 Data 2006 Data 2007 Data 2008 Data Most Recent Data Available
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