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Executives

Sara Furber - Investor Relations

John A. Thain - Chairman of the Board, Chief Executive Officer

Nelson Chai - Chief Financial Officer, Executive Vice President

Eric Heaton - Treasurer

Analysts

Glenn Schorr - UBS

Roger Freeman - Lehman Brothers

Mike Mayo - Deutsche Bank

Prashant Bhatia - Citigroup

Jeffery Harte - Sandler O'Neill

William Tanona - Goldman Sachs

Michael Hecht - Banc of America Securities

Meredith Whitney - Oppenheimer

Merrill Lynch & Co., Inc. (MER) Q4 2007 Earnings Call January 17, 2008 8:00 AM ET

Operator

Good morning and welcome to the Merrill Lynch fourth quarter and year-end 2007 earnings conference call. (Operator Instructions) I’d now like to turn the call over to Sara Furber, head of Investor Relations. Please go ahead.

Sara Furber

Good morning and welcome to Merrill Lynch's conference call to review the 2007 fourth quarter and full year results. The following live broadcast is copyrighted to Merrill Lynch. Statements made today may contain forward-looking information. While this information reflects management’s current expectations or beliefs, you should not place undue reliance on such statements as our future results may be affected by a variety of factors that we cannot control.

You should read the forward-looking disclaimer in our quarterly earnings release as it contains additional important disclosures on this topic. You should also consult our reports filed with the SEC for any additional information, including risk factors specific to our business and the information on calculation of non-GAAP financial measures that is posted on our investor relations website, www.ir.ml.com, where an online rebroadcast of this conference call will be available later today at approximately 11:00 a.m. Eastern Time.

Unless otherwise indicated, comments will exclude the impact of the one-time compensation expenses related to adopting FAS-123R in the first quarter of 2006, as well as the one-time net gains from the closing of the combination of Merrill Lynch Investment Managers, or MLIM, with BlackRock in the third quarter of last year.

In addition, comments will exclude the operations of both Merrill Lynch Insurance Group, MLIG, and Merrill Lynch Capital, which are now reported under discontinued operations.

Full GAAP financials which include these items are available in the attachments to the Merrill Lynch earnings release, as are schedules reconciling those data to the numbers that will be discussed.

Today I am joined by Merrill Lynch's senior management team, including Chairman and Chief Executive Officer, John Thain; Chief Financial Officer, Nelson Chai; and Treasurer, Eric Heaton.

And now I will turn the call over to John Thain.

John A. Thain

Thank you, Sara and good morning, everyone and thank you for being on the call. This morning I would like to start our call by making some comments on the firm’s results and the actions that the senior management team and I have taken since my arrival here about six weeks ago.

Nelson Chai, our new Chief Financial Officer, will briefly take you through our operating results. Afterwards, Nelson, Eric, and I are happy to answer your questions.

Today, as you know, we reported a net loss of $8.6 billion for the full 2007 year and a net loss of $10.3 billion for the fourth quarter. This quarter’s losses were primarily driven by write-downs of $11.5 billion related to CDOs and sub-prime mortgages, and $3.1 billion related to increased credit reserves against financial guarantor counter parties.

With these write-downs, the firm’s remaining net exposures to CDOs are $4.8 billion and to sub-prime mortgages are $2.7 billion respectively. And I want to emphasize the fact that the performance of the vast majority of Merrill’s businesses were very strong in 2007 and in particular, global private client equity markets and investment banking all had record revenues in 2007.

So let me first talk about what our focus has been for the first six weeks and then we’ll get into some more details on the results.

The first focus for the management team was on liquidity and remember the concern, particularly as we got to the end of the calendar year, was on how much of a liquidity squeeze there would be. And I am very pleased to say that we ended our fiscal year with $80 billion of cash and liquidity available to us at the holding company. That number was more than what we had targeted and we were very comfortable with our liquidity position, both at the end of the year and going forward. We also finished the year with over $100 billion of deposits in our banks.

We have been actively working to bring down the size of our balance sheet. We are reducing positions, particularly illiquid assets and freeing up liquidity, and we will continue to do that into the first quarter, particularly reducing carry type trades and illiquid assets within our fixed income areas.

The second main focus was on capital and as you already know, we raised $6.2 billion of common from Temasek and Davis Advisors, and we announced on Tuesday an additional $6.6 billion of mandatory convertible securities primarily from a Korean investment corp, Kuwait Investment Authority, and a Mizuho corporate bank and several other important investors. With those two capital raises totaling $12.8 billion we have, significantly greater than the losses, replaced our equity base and we have put ourselves in a position that we are well capitalized, both at the parent level and at our regulated subsidiary level, and we are very confident that we have the capital base now that we need to go forward into 2008 and beyond.

In addition to the capital raise, we also freed up capital. We freed up about $2 billion of additional capital through the sale of the vast majority of the assets of Merrill Lynch Capital and MLIG. And so we have the ability to continue to rationalize and redeploy our equity and our balance sheet and you’ll see us continue to focus on balance sheet management and allocation of capital as we go into 2008.

The other important piece of this, which is either already out or is in the process of coming out today, will be our rating and I do expect -- and I know some of them are already out this morning -- I do expect that all of our rating agencies will in fact reconfirm our ratings and that was one of the major focuses of the capital raise. And of course, we did the capital raise in advance of our earnings because we wanted to comfortably be in excess of the capital we had lost and be well capitalized and maintain our ratings.

The third focus is on people and organizational structure. I am committed to flattening out the organizational structure to broadening out the senior management team and to reduce what I perceive as some of the siloing that has taking place at Merrill Lynch over the course of the last few years.

Just in terms of the strengthening and bonding of the senior management team, as you already know, Nelson Chai is our new Chief Financial Officer. We’ve also brought back Jeff [Cronthal], who is a veteran of the mortgage area and he is helping us work through our CDO and mortgage related positions and I believe, I hope, later today we will also announce an addition to our risk management team. This is a senior experienced risk management person who will co-head our risk functions with Ed Moriarty. We are combining all of risk, both market and credit risk, in this new person and Ed will report directly to me, which is also a change in terms of the organizational structure.

I think it is very important that we emphasize to the organization going forward the importance of risk management. In the leveraged finance area, we actually did a very good job in risk management and as you have seen, we are -- our portfolio on the leverage finance side is in very good shape, but on the trading side, in particular as it relates to CDOs, we did not do a good job. And that really begins at the very first line of defense, which are the trade invests themselves.

So one of the other changes that I am going to make is I will bring in a new global head of trading and that is a newly created position, will also report directly to me. So we will be adding talent and emphasis on trading and we’ll be adding talent and emphasis on the risk management functions. And going forward, and this is a philosophical point, in our trading businesses, both equities and FICC, we will continue to take risk. Trading businesses don’t make money if they don’t take risk. But the risks that they take will be sized appropriately to the businesses. None of the trading businesses should be taking risks, either single positions or single trades, that wipe out the entire year’s earnings of their own business and of course certainly shouldn’t be taking a risk or wipe out the earnings of the entire firm.

We will be reducing the type of carry trades that are very balance sheet intensive. We will also move more of our illiquid assets type of investing into third-party funds. We are actually in the process of doing that already in the case of our Pacific rim real estate fund. So you’ll see us be more conservative in terms of the use of the balance sheet for illiquid assets but we are still in the risk-taking business.

We also have reinstituted a risk committee. That committee will meet weekly. It will include the heads of all of the trading businesses and it will include, of course, our risk management team and myself. And we’ve also added Bill McDonough, who’s a great resource to us. As you probably know, Bill has been at the scene of pretty much every major financial crisis over the last 25 years and so he will also be a great addition to that risk management function.

I also just want to comment on compensation philosophy because this gets to the broader topic of broadening out the management team and reducing the silos. We will change, and we are in the process of doing that now with this comp year, the compensation philosophy so that the first and most important thing is how well does the firm as a whole do and then the second impact will be how does the individual business area do and how do individuals do. And the other change this year has been an increase in the equity component of comp, and I think those two things will also help the development of a more team oriented atmosphere and focusing on the firm as a whole.

Now, before I turn it over to Nelson, I want to just make a couple of comments about why I chose to come to Merrill. I came here because I believe this is a world-class franchise. It has a tremendous brand. It has a unique set of businesses with a global footprint and it has a great culture. And I have been very impressed by how many of the Merrill employees talk about their commitment to the company, their long tenure with the company.

I was actually down in Arizona at a conference for the top managers of the global wealth area and the culture and the strength of the culture here is terrific. In spite of the difficult market environment and in spite of the changes at the top of the firm, I just want to reiterate how strong most of the businesses have done this year and of course, we are very optimistic as we look out into 2008.

But just to give you a couple of ideas, for the full year within FICC, rates and currencies, two business areas, set new revenue records, grew more than 60% year over year. Equity markets, as I said, had a record. Their revenues were $8.3 billion, up 23% year over year. Investment banking had record revenues, up 22%. And global wealth management reported revenues up 18% and pretax earnings up 41%. So the growth opportunities in our mix of businesses are very strong.

I also want to comment that at current prices, our BlackRock investment is worth more than $13 billion and it remains a core strategic asset from my perspective. It is not something that we would look to sell.

And I also believe that we have a great opportunity outside to the United States. Although the U.S. economy, and I guess we’ll see what Mr. Bernacki has to say today, but the U.S. economy is likely to be slower in 2008.

We continue to see great growth opportunities outside the U.S. and particularly in India, China, Latin America, Brazil, Russia, and really across the entire Pacific Rim. So I believe that the performance of our core businesses provides clear evidence that our business strategy is a good one, that we have great long-term prospects, and as I look out into 2008, I am very optimistic about our ability to perform for our shareholders.

So with that, I will turn the call over to Nelson.

Nelson Chai

Thank you, John. Let me reiterate John’s comments about how impressed I’ve been with the people I’ve met here and the strength of the Merrill franchise.

With that, let me briefly review our results. Fourth quarter net revenues were a negative $8.2 billion. Diluted earnings per share net earnings were also negatively impacted with Merrill Lynch reporting a net loss of $10.3 billion and a net loss per diluted share of $12.57.

Let me now review each of our major segments. GMI fourth quarter revenues of negative $11.8 billion were down substantially from prior periods, although our non-FICC businesses performed well. GMI revenues for the full year were negative $2.7 billion. GMI’s pretax loss for the quarter was $15.8 billion.

Turning to the revenue detail by business line, FICC results are dominated by write-downs of $11.5 billion related to U.S. ABS, CDOs, and sub-prime. In addition, FICC was negatively impacted by credit valuation adjustments of $3.1 billion related to the firm’s financial guarantor exposures and additional write-downs related to other residential mortgages, commercial real estate, and leverage finance.

Let me walk you through the major buckets.

On the CDO front, the vast majority of our losses in this quarter are related to U.S. ABS CDOs and the net exposure related to these positions is currently $4.8 billion. As you can see in our release, net exposure at the end of the third quarter was $15.8 billion, which was reduced by $9.9 billion of net write-downs and $1.1 billion of other net changes, which includes interest amortization and the impact of hedging activity.

Our super senior ABS CDO long exposure, which excludes the impact of the hedges and short positions, is $30 billion at year-end post write-downs. At the end of the fourth quarter, our high grade net exposure was approximately $4.4 billion, our mezzanine net exposure was approximately $2.2 billion, our CDO squared net exposure was approximately $270 million, and our CDO secondary trading positions were net short, or negative approximately $2 billion.

Our valuation of these exposures takes into consideration the deteriorating market conditions for these securities, as evidenced by declining indices, such as the ABX remittance and cumulative loss data.

The majority of write-downs this quarter were related to the firm’s U.S. high grade super senior ABS CDO exposures. A significant portion of the underlying collateral for our super senior exposures is comprised of 2006 vintage mortgages, which have been valued using cash flow analysis with cumulative loss assumptions primarily between 16% and 21% based upon multiple inputs, including market data and projections for future collateral performance.

During the fourth quarter, we recorded substantial credit valuation adjustments of negative $3.1 billion related to hedges we had with financial guarantors, which include a credit valuation adjustment to write down the firm’s current exposure to a non-investment grade counterparty.

For U.S. super senior ABS exposures, our hedge related credit adjustments were negative $2.6 billion. While we use a range of counterparties, such as financial guarantors, insurance companies, and hedge funds to wrap and hedge a variety of products, as of year-end we had $14 billion of net notional super senior ABS CD exposure that was hedged with financial guarantors, of which the vast majority was against high grade exposures with high attachments.

On the sub-prime and other residential mortgages, within our sub-prime mortgage business, our exposure is $2.7 billion and in aggregate, our net write-downs related to these exposures totaled $1.6 billion during the quarter. These enabled to meaningfully reduce our exposure to the completion of whole loan sales and securitization transactions during the quarter.

In addition to our sub-prime related exposures, we also took marks of approximately $400 million on our U.S. Alt-A exposures and $500 million on our mortgage exposures outside the U.S., as sub-prime contagion spread to other residential markets.

On the commercial real estate and leveraged finance front, within our commercial real estate business our aggregate net write-downs totaled approximately $230 million for the fourth quarter and were the result of spread widening and market illiquidity.

Within leveraged finance, net write-downs of approximately $126 million were recorded with respect to these financing commitments.

Finally, within our U.S. bank and related investment securities portfolio, we recognized a $1.3 billion of net write-downs through other comprehensive income, or OCI, and $869 million of net write-downs through the income statement. These adjustment primarily relate to U.S. sub-prime and ABS CDO securities and are in line with adjustments we have made to comparable securities outside our bank’s investment securities portfolio.

Apart from those areas discussed above, the challenging business environment affected all of our major FICC business in the fourth quarter. Rates and currencies both generated record revenues for the full year but were down substantially during the fourth quarter from record third quarter levels as the benefit of increased volatility was offset by substantially weaker client flows and decreased trading opportunities, particularly in December versus September.

During the quarter, our MUNI business also experienced sequential declines as issuance slowed amid mono-line credit fears. Offsetting these declines was a net benefit of approximately $800 million during the quarter related to changes in the carrying value of certain long-term debt liability.

Turning to equity markets, fourth quarter net revenues of $2.2 billion were up 23% compared to the year-ago quarter. Equity markets full year net revenues reached a record $8.3 billion, up 23% from the prior-year period. For the fourth quarter, we reported significant year-on-year revenue increases in our equity-linked, cash and financing and services businesses, with our prime brokerage client balances up over 50% year over year.

These revenue increases were partially offset by declines in proprietary trading. Sequentially, prop trading rebounded off a weak third quarter while the prime brokerage business experienced declines, reflecting the seasonality of yield enhancement business I Europe. This quarter’s results also included approximately $500 million in fair value adjustments related to certain long debt liabilities.

In investment banking, we continue to demonstrate global strength and generated solid revenues, despite slower market activity levels in November and December, with revenues of $1.2 billion in the fourth quarter, up 15% on a sequential basis.

Revenues for the full year increased 22% over 2006 to a record $4.9 billion. This quarter, our advisory revenue set a new record and we’re up significantly, both sequentially and year over year, while debt origination revenues were down in both comparable periods due to continued weakness in leveraged finance origination revenue. Equity origination was mixed, up slightly from the third quarter but down from the prior year period.

During the quarter, Merrill Lynch ranked first in global equity and equity linked transactions and number two in global debt and equity fees. And for the full year, we finished in a top five ranking across global debt, global equity and equity-linked, and global completed M&A.

Our investment banking fee pipeline remains strong. We ended the year down from peak levels in 2007 but higher than the 2006 year end, with particular strength in advisory and equity under-writing mandates.

Turning to GWM, GWM had again another strong quarter, with record revenues of $3.6 billion, up 12% year-on-year and 2% sequentially. Even in this challenging period which included significant market volatility, pretax earnings of $914 million were up 30% year over year and pretax margin was 25.4%.

For the full year, GWM generated significant revenue and pretax earnings growth of 18% and 41% respectively, while achieving a pretax margin just under 26%. This year, we continued to make significant strategic progress in our global wealth management business. In the third quarter, we closed our acquisition of First Republic and in the fourth quarter, we completed our planned sell of MLIG, which resulted in an after-tax gain of $316 million, which is being reported under discontinued operations.

GPC net revenues in the fourth quarter were $3.3 billion, the second-highest achieved in any quarter, up 10% from the prior year period. Fourth quarter revenue growth was driven by record fee-based revenue, which reflected higher market values and fee-based assets. Transaction and origination revenues were up slightly from the prior year quarter but down sequentially from the third quarter of 2007, which included revenues of $128 million related to a sizable transaction.

For the full year, GPC’s record revenues of $12.9 billion were up 14%. We achieved the strongest annual net new money in over seven years of $80 billion. Client assets reached $1.7 trillion, just 1% off the record reached at the end of the third quarter.

Success in retaining our industry-leading team of financial advisors in 2007, representing the fourth consecutive year we have grown our FA [headcount] by at least 5% while maintaining an annualized revenue per FA of $860,000. This is even more impressive considering that our industry-leading trading program, from which we derive significant future benefits, actually dilutes this metric in the near term until trainees become fully productive.

Positive recruiting against our peer group and turnover, which continues to be at historically low levels of our top two quintile, FA growth of 21% and revenue growth of 24% outside the Americas. And during the quarter, we transitioned more than $100 billion of client assets from our MLUA accounts into other platforms and virtually no client assets were transferred outside of Merrill Lynch. Excluding the impact of the MLUA transition, our net annualized -- annuitized would have been over $20 billion for the quarter.

Moving on to GIM, which generated net revenues of $286 million for this quarter -- year-over-year growth of 36% was driven primarily by BlackRock earnings growth and increased revenue from our businesses that creates alternative investment products for GPC clients.

Also this month, we reached an agreement to sell our 20% stake in GSO Capital to Blackstone, which we expect to result in a modest gain but a significant return on investment. Blackstone will broaden its asset management capabilities with the addition of GSO and we will be an investor and distributor of a GSO-managed fund. This transaction demonstrates our success in taking strategic equity stakes in world-class money managers.

That concludes my discussion of the segments. Now I’ll turn briefly to the firm as a whole and discuss expenses.

I’ll start with compensation expenses, which for the full year were up 6% from 2006 levels but down on a per headcount basis given our performance.

For the quarter, compensation expenses were $4.3 billion and reflect the results of year-end accruals made for 2007, increased headcount levels from 2006, and increased productivity from FAs.

On the non-comp costs, they increased 25% to $2.4 billion for the quarter, largely related to acquisitions and headcount growth, ongoing investment in our GMI and GWM technology platforms, and significant growth in BC&E expenses associated with strong volumes in equity markets, rates, and currencies in GWM.

Non-compensation expenses included $53 million from write-off of First Franklin intangibles, as well as $60 million in expenses related to First Republic in the fourth quarter of 2007.

Managing the firm’s expenses to be better in line with the business activity will be a key focus of mine as we turn into 2008.

At year-end, total capital was $36.7 billion and pro forma for the impact of all the announced offerings and the exercise of the Temasek option, it would have been $45.7 billion.

Treating the preferred securities on an if converted basis, our pro forma adjusted book value per share would have been $32.80, and our effective tax rate was 32.7% for the full year.

Finally, in terms of the outlook, we remain cautious in the near-term and continue to monitor the U.S. economic environment. We are particularly focused on the residential housing market. However, we believe the recent actions we’ve taken significantly better position us to navigate this operating environment. Additionally, as John referenced, Merrill Lynch is truly a global firm. We continue to be optimistic regarding our long-term growth opportunities in each of our major business lines, particularly outside the U.S.

With that, John, Eric, and I are happy to take your questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of Glenn Schorr with UBS.

Glenn Schorr - UBS

Thanks very much. John, a follow-on to your comment on balance sheet rationalization; in terms of reducing the carry trades and illiquid assets on balance sheet, any numbers, guess you can throw at it in terms of what percentage that might reduce the overall balance sheet? What kind of metrics are you looking at in terms of productivity?

John A. Thain

There’s two important pieces of that. One is reducing the carry trades and we are going to do that really over time, so I think you’ll see progress -- you saw a little bit of progress at the end of the year. You’ll see more progress over the next two quarters.

The second piece of it will be to move more of the illiquid assets into third party funds. So I mentioned commercial mortgages, the Pacific Rim real estate fund is already in the process of being created and so we will move some of the assets directly into that.

I think you’ll see us over the course of the next year create private equity third party funds, as well as I think infrastructure and perhaps special situation types of funds. So philosophically, we will move those types of illiquid assets into third party fund structures. And so overall, you will see our balance sheet shrink and then you saw with the sale of ML Capital, we’ll reduce those assets. The first sale was about $10 billion and there’s another $4-odd billion to go.

So we will in fact be shrinking it without giving you specific target levels.

Glenn Schorr - UBS

And it’s fair to assume that you feel you’ve written down your illiquids to a point where you could transfer them into a third party fund at fair value?

John A. Thain

Yes, although most of the write-downs are in CDOs and sub-prime, so those unfortunately won’t go into third-party funds. But we’re very comfortable that given where we’ve written down those assets, that these are at levels at which we believe they are either saleable or actually represent good value.

Glenn Schorr - UBS

I think you touched on private equity and infrastructure funds, but can you maybe talk about your thoughts around Merrill’s presence in other areas that were being built over the last couple of years, like structured credit leverage, finance? In terms of do you think that obviously these markets are slower so you’ll right-size your infrastructure, or is there more of a sea change in terms of Merrill’s attitude towards those?

John A. Thain

Those are two different areas. On the structured credit side, that will be dramatically reduced. On the leveraged finance area, we think we are already in a very good spot and I would expect us to continue to manage it but we will add where it makes sense exposure to the leverage finance area. So actually we’re happy with our leveraged finance position.

Glenn Schorr - UBS

Okay. Thank you.

Operator

Your next question comes from the line of Roger Freeman with Lehman Brothers.

Roger Freeman - Lehman Brothers

Nelson, did I hear you right that you’ve got $30 billion of gross exposures still on in CDOs, ABS CDOs?

Nelson Chai

Yes.

Roger Freeman - Lehman Brothers

Can you talk a little bit to the hedges that you do have around that? Obviously the big difference between that and the $5 billion net and basis risk around that?

Nelson Chai

Well, I guess what I would say, Roger, is that I think where the book is marked right now reflects as of 12/31 as best we could where we think those positions were. And as you know, under FAS-157, everything was level three. We triangulated around a bunch of different modeling assumptions and a lot of obviously external metrics to come up with what we thought was the right range, if you will.

As you know, I spent some time both internally here but also externally going around the street and getting a sense as well, so we felt we came up with the most -- a very comfortable range where we though the book should be marked and within that range, I would say that we took a pretty prudent view, if you will, about where we should put those marks.

We have dug in to look at some of the hedges we have against it. You’ve seen us take a little bit on the credit side on some of the counterparties. We obviously continue to watch closely those counterparties but again, I think that we feel comfortable with where the book is marked as of the end of December.

Roger Freeman - Lehman Brothers

What is the game plan for reducing these exposures over time? And were there any assets sold off during the quarter? I don’t know if you can quantify that or not. And just maybe just any sort of thoughts you have about what it’s going to take to get some sort of secondary market going here. There’s a lot of growth exposure here over time that you need to wind down.

John A. Thain

In terms of actual sales in the fourth quarter, there were a few but very small, although the ones that we did sell were right around where they were marked, so that was a good thing.

I would hope that the market becomes more liquid as we get into the first quarter so we can actually sell more of them but I would say that these -- focusing on the gross number without giving credit to the hedges is really not the right way to look at it because we do have $23 billion of shorts, plus we also have a short in our trading book. And the net exposure is still dramatically reduced from where it was at the third quarter.

So the hedges are not perfect, that’s certainly true, and they do create some credit exposures to the mono-lines. But we still think that given the reduction in net exposure, it’s pretty dramatic.

Roger Freeman - Lehman Brothers

Okay, and just on the hedge counterparties, as I look at this table in the back of the release, the hedge that you have with AC, which I guess is a non-investment grade one mainly here, is that -- what are you actually carrying any ACA hedges at at this point? Is it anything above zero?

John A. Thain

We are reserving against ACA dollar for dollar, so it’s 100% reserved.

Roger Freeman - Lehman Brothers

One-hundred percent reserved, okay. I guess lastly and I’ll jump back in the queue, the compensation expense seemed a bit high and I’m wondering, is there a charge in there related to the acceleration of the stock vesting? And how much is that?

Nelson Chai

Well, we did accelerate, as I think --- some one-time acceleration but again, that would have been pretty small, about $183 million in the fourth quarter, Roger. A lot of it had to do with if you look at the third quarter comp number, it looked a little bit out of line and again, it was a true-up, if you will, on the September year-to-date basis, based on comp ratios. And so in the fourth quarter, we had to take the accrual based on where we were going to pay people and as John mentioned earlier, across the business franchises, with the exception of parts of our fixed income business, the businesses had record years and so we needed to compensate people for a lot of reasons, including retention accordingly.

So that has a lot to do with it, of where it came out.

Roger Freeman - Lehman Brothers

How much was the stock/cash mix this year compared to last year in bonuses?

John A. Thain

The mix on the bonus part was approximately 60-40.

Roger Freeman - Lehman Brothers

And what was it last year?

John A. Thain

I wasn’t here last year, but it’s more -- it’s certainly more stock and that’s the direction we’re going.

Roger Freeman - Lehman Brothers

Got it. Okay, thanks.

Operator

Your next question comes from the line of Mike Mayo with Deutsche Bank.

Mike Mayo - Deutsche Bank

Could you elaborate on the diluted share count ahead with the new equity issuance?

Nelson Chai

Sure. As of the end of the year, the common shares outstanding was 939.1 million. If you do the adjustment for the common share round, that gets you up to 988.3, and then if you look forward and adjust for the mandatory, it gets you up to 114.2.

Mike Mayo - Deutsche Bank

I’m sorry, the last number was?

Nelson Chai

1114.2, sorry.

Mike Mayo - Deutsche Bank

Okay, and so fully diluted shares, just for our models for 2008, should be --

Nelson Chai

The 988.

Mike Mayo - Deutsche Bank

Okay and with regard to -- more back on the strategic level, John, any thoughts about further changes in the business mix? You announced a few asset sales. What’s the thought about more?

John A. Thain

In terms of asset sales, there’s really no other asset sales. The only other big asset that we have, I was specific about BlackRock, which I said we would not sell. The only other specific asset that we have is our stake in Bloomberg. You all know we have about a 20% stake in Bloomberg, which we carry basically at zero and we are not looking to sell that.

Mike Mayo - Deutsche Bank

Okay. And then lastly, you itemized some exposures in other areas and one of those areas was commercial real estate. I guess you had $230 million of write-downs. How comfortable are you with that $18 billion portfolio?

John A. Thain

We have spent a lot of time on that portfolio. We’ve gone through that really almost name by name and both Nelson and I, Jeff, the guys who run that, and actually we are very comfortable with that portfolio and how it is marked.

Any commercial real estate portfolio is somewhat sensitive to overall economic environment but given where we are, given the types of properties that they are, given the structure of those deals, we’re very comfortable that these things are conservatively marked.

And given the size of the portfolio and given the size of the mark, you can see that it’s a pretty high quality portfolio.

Mike Mayo - Deutsche Bank

Thank you.

Operator

Your next question comes from the line of Prashant Bhatia with Citigroup.

Prashant Bhatia - Citigroup

Just in terms of the philosophy of balancing ROE versus earning, I guess what is the philosophy there and what is your view of a sustainable ROE of the firm once you make some of the changes that you’ve got planned?

John A. Thain

Well, as you know, there is always a trade-off between ROE and dollars of earnings and whenever you put things into fund forms, you can increase your ROE at the expense of dollars of earnings.

Let me give you this type of guidance -- if you look in 2006, or if you looked at what 2007 would have been ex the losses, which would have been comparable to 2006, the ROE was around 20%.

Prashant Bhatia - Citigroup

Okay, so you can generate over time sustainable ROEs in excess of 20% as you make some of the changes that you are planning on?

John A. Thain

We believe so.

Prashant Bhatia - Citigroup

Okay. And then, can you give any sensitivity to the cumulative loss assumptions? I think you said 16% to 21%. It’s clearly not linear so if it ends up being higher or lower, can you give any kind of sensitivity there on the impact?

John A. Thain

The problem is, as you know, that the -- it’s very dependent on the deal structure on a name-by-name basis. It’s dependent on the vintage of the mortgages. The 16% to 21% was intended to give you the kind of -- the average range that we are looking at.

It’s very hard to get much more detail to that other than -- unless you actually run the individual positions. The only thing I would say is we believe that we are being conservative on these marks and we think that at the levels that they are marked, we will in fact be able to sell them and/or that they represent value at where they are marked.

You know, at some point as you mark these things down, they approach their aisle value and they really don’t have as much downside going forward once you get the marks low enough.

Prashant Bhatia - Citigroup

Okay, and maybe asking it another way, you’ve taken over $20 billion in write-downs over the last couple of quarters. What percentage of that would you say is a write-down to reflect a market environment that exists today that may not exist tomorrow? For example, how much do you think is really a liquidity type mark based on the environment?

Nelson Chai

I think if you look at it, it’s reflective of what we think the book was at the end of December, as I said earlier. And certainly in December, the market was a lot less liquid for these types of instruments and so I think there is a little bit of that built in. We’re not going to sit here and predict the future. We certainly hope, and I think everybody should hope, that it brightens but again certainly our job here was as of December and frankly, as you look at us versus some of our peers who were November, I think there’s a change in timing in the quarters, both in terms of the business environment in December versus what they would have had as an August environment, which at least on the equity side was very good.

And then you actually have to look at as people were taking their marks and again, December there was not a lot of trading going on, particularly in the back half of December.

John A. Thain

I’m not sure if you’re trying to get at whether there’s the ability to recover some of the losses here.

Prashant Bhatia - Citigroup

Yeah, that’s exactly what I’m trying to get at.

John A. Thain

That’s what I thought. I think on the CDOs specifically, I think it’s not likely that these things are going to recover because the fundamental assumptions as to home price declines and cumulative losses, I think, as I said, I think we are being conservative but I don’t think that we’re likely to get much back on these things. So I don’t think it’s like a -- just where you have an illiquid market where the liquidity comes back and you recover a lot of it. I don’t think that’s going to be the case here.

Prashant Bhatia - Citigroup

Okay. And then, can you elaborate on the comments on BlackRock? You clearly think it’s a core, strategic asset. What drives that view and maybe some specifics on what both firms can do together going forward?

John A. Thain

I don’t really know what more to say about it other than it is a strategic asset. It is a -- the whole strategy of separating the manufacturing from the distribution, we fundamentally agree with and so there are -- there actually are quite good linkages. As you probably saw yesterday, [I have gone on the board] and so I think that the working relationship between the companies is great and we do not intend to do anything that would change that.

Prashant Bhatia - Citigroup

Okay, and then just finally, maybe your initial take on the retail brokerage business. I know you spent a very long time at firms that kind of stayed away from directly touching the retail consumer. I guess just some initial takes on that business.

John A. Thain

Well, as I said, I was down in Arizona with the leadership of the high net worth business. The wealth management business is a great business. It is -- Merrill’s wealth management business I think is the best in the world and it is one of the great strengths of our franchise.

It is relatively immune to the ups and downs, at least short-term ups and downs in the marketplace. It continues to grow very consistently, as I think you know. The fourth quarter, in spite of being a difficult environment both for us as well as in the marketplace, we added net new assets of $30 billion in the fourth quarter.

So it is actually is a great business and it’s a great source of stability.

Prashant Bhatia - Citigroup

Okay. Thank you.

Operator

Your next question comes from the line of Jeffery Harte with Sandler O'Neill.

Jeffery Harte - Sandler O'Neill

You mentioned I think correctly that structure product activities, or at least market demand for those things, is probably going to be gone for a while. Looking at the size of the balance sheet marks, we have an idea how much you are exposures to those were. Can you give us any indication as to how big a contributor to revenue those businesses that you don’t think are going to be coming back anytime soon were over the last year or two?

John A. Thain

We won’t be specific on that but as we are in the process of budgeting out 2008 now, and of course we don’t give guidance so we are not going to actually answer any specific questions about what we think about 2008, but from the comments I made about the return on equity, from the comments I made about the earnings power of this franchise, whether you look at 2006 or whether you look at what 2007 ex the marks in terms of how comparable that would have been to 2006, I think that that gives you at least some idea as you are thinking about this.

And our thoughts about 2008 and forward take into account the fact that the FICC business is going to be less balance sheet intensive and have less structured credit components to it.

You know, if you look at the core businesses inside FICC, I talked specifically about rates and currencies and I also talked specifically about the commercial real estate area. The commodities business also is a very good business and so you are going to see us focused on those parts of the fixed income area.

Jeffery Harte - Sandler O'Neill

There may not be an answer to this question, but as you talk about trying to beef up the trading risk management side of things, relative to what happened in leveraged finance, or fixed leveraged lending, do you have any kind of concept as to how long it may take to get things up to where they need to be from a systems or a personnel -- maybe just a culture. I mean, is it quarters, is it years, is it decades?

John A. Thain

No, no, no -- in personnel, it’s going to start today because we’ve already been working on it. In terms of culture and philosophy, it’s already started a month ago. And as I said, Ed Moriarty and the new person we are hiring will report directly to me. That’s as strong a signal to anyone.

And I think that these are changes we are in the process of making now. You will see the impact right away.

Jeffery Harte - Sandler O'Neill

Okay, and finally, you mentioned BlackRock as a strategic asset. You also mentioned that Bloomberg was not for sale. In light of the amount of capital you are raising in dilution from that, did you consider selling the Bloomberg stake? And if you did, why didn’t you sell it?

John A. Thain

Let me answer it in the following way -- obviously the Bloomberg stake generates a certain income stream and so you could -- we could and did make the trade-off of selling the stream of income from Bloomberg versus selling the stream of income from the company as a whole and we decided that it made more sense to market the common and mandatory conversion of the company as a whole.

Jeffery Harte - Sandler O'Neill

Okay. Thank you.

Operator

Your next question comes from the line of William Tanona with Goldman Sachs.

William Tanona - Goldman Sachs

Good morning. As we look at the marks on the CDOs, you guys were fairly aggressive on the high grade stuff but not as aggressive on the CDOs squareds. I guess can you help me understand what drove that decision, just given the collateral underlying those structures? Was it vintage? What was it that those write-downs weren’t as aggressive? And I guess also what type of home price depreciation are you factoring into your cume loss assumption?

Nelson Chai

As you get into the mezz and the CDO squared, you really start getting close to [IO] value, as John mentioned earlier. So as we thought about pricing it down, that really was kind of the floor, if you will, in terms of how we got to it. And that’s also why you saw a less dramatic mark, if you will, in the December period.

John A. Thain

Yeah, but I want to add one thing -- if you look at -- as you know, you have to model out the individual positions and there’s no very good way to look at average prices and it also does depend on the collateral and the vintage, et cetera, et cetera. So there’s a lot of caveats to it.

But still, if you look at where we carried the value of the mezz divided by its principal amount, which gives you at least some idea of the change in value, if you did that at the end of September, it was in the low 60s. And if you did that at the end of December it was in the mid 20s. So it’s still a pretty significant write-down.

William Tanona - Goldman Sachs

Okay, and then you mentioned the change in philosophy as it related to comp. Is that something that you envision firm wide, even in the global private clients group? And how would you go about changing the philosophy in that business?

John A. Thain

No, it doesn’t include the global private client group and no, I don’t intend to mess with their compensation structure.

William Tanona - Goldman Sachs

Okay, and then just lastly, you’ve obviously been there for a couple of weeks. Was it better, worse, or what you had expected as you got into it? And then as I think about all of this exposure, how was it that you guys ended up with so much of that exposure? Was it just the underestimation of what the actual risks were? And these assets, was it a failure of reporting this stuff into the risk management systems? How was it that you ended up with this large of an exposure in the CDOs and sub-prime?

John A. Thain

The second part of that question is a little bit harder to answer since I wasn’t here, but in terms of what did we find, I think as in any time you enter into a new job or new organization, some things were better than we thought and some things were worse. I would say specifically the leverage lending portfolio is significantly better than I would have thought and the CDO portfolio was worse.

How did we get here? Well, I’m not sure it’s so useful to try to go back into that, rather than just saying we’re focused on going forward. I think that where we have marked these CDOs, we are comfortable that we are in very good shape looking into the future. And given the capital raise, we were very deliberate in raising more capital than we lost for the year so that we can position ourselves to look forward into 2008, that we are well capitalized on any different measure, that we will not be going back into the equity capital market.

So we are really going to focus on going forward rather than exactly how did this happen. Other than, the other piece I would say is the combination of the changes in philosophy, changes in risk management, changes in trading personnel, we’ll certainly make sure this doesn’t happen again.

William Tanona - Goldman Sachs

Okay. I guess I thought it would have been important to understand how you got into this situation to make sure it doesn’t necessarily occur in the future. Thanks.

Operator

Your next question comes from the line of Michael Hecht with Banc of America.

Michael Hecht - Banc of America Securities

I know it’s early days, but I just wanted to get a quick sense from you about where you plan to make investments in the franchise and where you are optimistic for growth for ’08 and beyond. Are you worried about -- I know you mentioned this in your prepared remarks, an economic growth slowdown and contagion of some of the areas in mortgage and credit spreads -- you know, other areas that seem to be doing quite well, like equities and retail?

John A. Thain

I think actually as you look across our mix of businesses, we actually see pretty good opportunities across the board, but I’ll go through specifically. On the investment banking side, we had a record year. We continue to believe that we have a great position. I would expect that our banking franchise will be stronger outside the U.S. versus inside the U.S., given the expectation of a slower U.S. economy. But if you look at our institutional business, so if you take out the high net worth business, over 60% of our revenues are from outside the U.S., so we are well-positioned to see further growth outside the U.S.

In particular, we are strong in the Pacific Rim, so India, China, Brazil. I think outside the U.S. we’ll continue to grow.

Our equity business has done very well. You know, the trading businesses, they are helped by the volatility in the marketplace and we’ve seen a lot of that. And as I said before, on the fixed side the currency business, the rates business, the commodities business are all good.

And then another place that I think you’ll see us grow, although as I said we’ll grow in terms of third-party fund structures, is in the principal investing area. We do have a small principal investing business. We can certainly make it bigger. As I said, we are raising a third-party fund in the Pacific Rim on the real estate side.

And then the last area I guess I would emphasize is the wealth management business outside the United States. We have a great franchise here in the U.S. but I think there are very strong growth opportunities outside the United States. Again, if you look at where wealth is being created in the world, it’s in the Middle East and it’s in the Pacific Rim, and then to some extent in Latin America, particularly in Brazil.

So those parts of our businesses I think have great opportunities.

Michael Hecht - Banc of America Securities

Okay, that’s helpful. And then maybe a bit more color or update on staffing and headcount reductions at GMI -- what areas you’ve made cuts in and I guess outlook for number of heads as you look into end of ’08 versus where you ended ’07, again for GMI?

John A. Thain

Well, if you look at our overall headcount, our overall headcount is basically flat but there are pluses and minuses in that. The FICC headcount was down about 1,000 people and of course we bought First Republic, and that added about 1,000 people, so the net number -- and then, of course, the financial advisors continued to grow so the net number is approximately flat.

I think you will still see some headcount reductions in FICC but they are not, in the scheme of things, this is not a case where we are targeting thousands and thousands and thousands of people. They will be selective reductions in places like structured credit and probably there is still more opportunity to do headcount reductions in our various mortgage origination platforms. So I think those are the two places you’ll probably see but it’s not going to be dramatic.

Michael Hecht - Banc of America Securities

Okay, great. And then just to come back on retail, I mean, great year no matter how you look at it -- flows, productivity, growth in brokers, assets -- I guess the question is, what do you really do for an encore in that business and how can you draw out the value of that franchise, which I don’t think you get credit for in your stock price? And then, are you seeing any signs that the retail investor is going to fall out of bed here? I mean, it’s been relatively resilient.

John A. Thain

Well first of all, I hope you guys help us get credit in our stock price because as you all know, if you simply put a multiple on the earnings out of the wealth management business, you basically get the market value of the whole company, so I assume that you all will help by telling how cheap our stock is.

In terms of the U.S. wealth management business, I just think it will continue to grow. It grows at a nice rate. I don’t see any particular reason for the retail investor to fall out of bed here, so I think the U.S. will continue to grow at the type of rate it’s been growing.

And I think the big opportunity for us is outside the U.S., and so if you looked at well, where is there incremental upside, it will be with the high net worth business outside the U.S.

Michael Hecht - Banc of America Securities

Okay, that’s great, and then just two quick housekeeping things; liquidity position, you mentioned $80 billion -- can you say what that was a quarter ago and a year ago?

John A. Thain

Eric can answer that.

Eric Heaton

Sure. At the end of the third quarter, that number was $73 billion and at the end of last year, it was in the mid 70s as well.

Michael Hecht - Banc of America Securities

Okay, great. And just within equities, and you may have said this but there was a little bit of disturbance in your prepared remarks, Nelson, the equities business, how much were private equity losses in Q4? I’m assuming -- and that would suggest core strength -- you saw there was even better than the reported number, I think.

Nelson Chai

Private equity losses was $14 million in the fourth quarter.

Michael Hecht - Banc of America Securities

Okay, so not --

(Multiple Speakers)

Nelson Chai

Sorry, 114, sorry.

Michael Hecht - Banc of America Securities

One-hundred-and-fourteen, okay, great. Thank you.

John A. Thain

And by the way, that is really just marking to market the positions we own in publicly traded stocks. So we don’t -- that’s just a fluctuation in the market value.

Michael Hecht - Banc of America Securities

Yes, got it. Thank you.

Operator

Your final question comes from the line of Meredith Whitney with Oppenheimer.

Meredith Whitney - Oppenheimer

Good morning. I have a few questions. I appreciate your answer to Jeff’s question about not wanting to discuss the exposure in terms of exposure to revenue to structured products, but could you provide -- and I’ll go back and do the math and try to do it myself, but could you provide some color in terms of your exposure on a revenue basis to the MUNI market?

And then the second question is with respect to the fact that on a go-forward basis, you see strong markets in the credit markets in terms of rates and currencies, and then in commodities. Could you provide color in terms of what went wrong this year with your commodities business?

And then the third question, third and final question, is if you guys are so comfortable with your carrying values on your CDO exposures and sub-prime exposures in aggregate, why not just dump the assets? Why not -- why didn’t you purchase the assets in the fourth quarter?

John A. Thain

Let’s go backwards because I can do -- I can go backwards -- we’ll start with the CDO. There really was very little liquidity. There was very little trading by anyone in the CDO market, so as I said, we sold small pieces of them. But there’s no question that we intend to sell them going forward. We intend to reduce the absolute position. Jeff is -- Jeff understands that that’s his job to do that and we are optimistic that as the market starts to open up and actually trades really occur, that we can actually sell these things at levels that either at or near where they are marked.

So the intention was to mark them where we could sell them, and so I hope we do in fact see some trading happen and we’ll have to see. So far this year, there really hasn’t been any significant amount of trades done but our goal is to sell them.

Meredith Whitney - Oppenheimer

But isn’t that because the buyers aren’t coming to market -- sorry, the sellers really aren’t coming to the market? There are bids out there but the sellers don’t want to concede to those bids?

John A. Thain

I don’t think that’s right. I think there will be buyers. There’s a number of people raising funds to do this. I actually think that there will be a lot of money made in this marketplace and so I think that the people who are putting these distress mortgage funds together will eventually come in the marketplace to buy them, but it’s not really true that today there’s a big buyer’s market. I think there will be but it hasn’t really happened yet.

Meredith Whitney - Oppenheimer

Okay, in terms of the other questions, please?

John A. Thain

Yeah, I know -- my handlers are telling me that we don’t disclose the specific P&L items of individual business lines like MUNIs, but when I look at what that number actually is, it is -- it’s really not -- it’s not going to be the driver, either positive or negatively, to our results going forward.

I mean, look, MUNIs are still a good business and we are still committed to doing it but it’s not going to -- it’s not going to be the place that you are going to want to spend too much time on. It’s just a good, consistent business, that’s all. But in terms of percentage of the total, it’s not that big. And look, it’s a business that’s also not going to change that much going forward. I don’t see the MUNI business as a place where there’s a huge upside in terms of changes to our P&L.

In terms of the commodity business on the other hand, I think there is a lot more upside to the commodity business and I think that is an area where we do in fact have a lot more upside, so I am optimistic that we can actually do a lot better in the commodity business.

One of the places where we really didn’t -- we weren’t really positioned properly is in oil itself, so we just recently hired an oil trader and actually I think that there is -- there are opportunities for us to do much better in commodities.

Operator

Ladies and gentlemen, let me now turn the call back to Sara Furber for some final remarks.

Sara Furber

Thank you. This concludes our earnings call. If you have further questions, please call investor relations at 212-449-7119. Fixed income investors should also call 866-607-1234. Thanks for joining us today. We appreciate your interest in Merrill Lynch.

Operator

Thank you for participating in today’s conference call. You may now disconnect.

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