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Executives

Sara Furber – IR

John Thain – CEO

Nelson Chai - CFO

Analysts

Roger Freeman - Lehman Brothers

Prashant Bhatia - Citigroup

Meredith Whitney – Oppenheimer

Patrick Pinschmidt – Morgan Stanley

Glenn Schorr - UBS

William Tanona - Goldman Sachs

David Trone – Fox-Pitt, Kelton

Jeffery Harte – Sandler O’Neill

Merrill Lynch & Co., Inc. (MER) Q2 2008 Earnings Call July 17, 2008 5:00 PM ET

Operator

Good afternoon and welcome to the Merrill Lynch second quarter 2008 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 afternoon and welcome to Merrill Lynch's conference call to review our second quarter and first half 2008 results. The following live broadcast is copywrited 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 7:00 p.m. Eastern Time.

And with that, I will turn the call over to John Thain, Merrill Lynch's Chairman and Chief Executive Officer.

John Thain

Good afternoon everyone, thank you all for being on the call. I’d like to make a few opening comments and then I’ll turn the call over to Nelson to go through the details. This was obviously a difficult and disappointing quarter for us in terms of bottom line. The losses that were generated were almost exclusively from our existing mortgage and mortgage-related positions and from our exposures to the mono lines. Those positions continued to deteriorate in value over the course of the quarter particularly because our quarter ended in June and the last two weeks of June were a particularly difficult time.

I would like to emphasize a couple of points, first our core franchise, the efforts of our 60,000 plus people remains very strong. Excluding marks and credit valuation reserves and fair value adjustments, our core franchise generated $7.5 billion of revenues for this quarter and that’s in a difficult market environment. On a pre-tax basis that would be just under $2 billion of pre-tax income in the quarter. So we are very confident with our business strategy and the earnings power of our core franchise.

If you just get into a little bit of the detail and Nelson will do this more, on the Global Markets and Investment Banking side, investment banking had over $1 billion of revenues in the quarter. We were the number two merger advisor for the first half of the year in EMEA; we’re the number three in terms of global debt and equity fees. Our trading businesses also had a number of important positive areas. We had record revenues in both our rates and currencies business for the first half. Our commodities business was up 57% year-over-year and we had record revenues in our prime brokerage business.

The international component of our business continued to grow. We were up 13% overall versus the first quarter and our EMEA business was up 30% and the pipeline in investment banking continues to hold in. Year-over-year the pipeline is down only 7% versus the second quarter of 2007. So the banking sales and trading businesses were doing well and the Wealth Management business also in a difficult environment continued to do well.

And $3.4 billion of revenues down slightly from the first quarter, 22% pre-tax margin, a continued increase in our annuitized products, about $8 billion in addition to annuitized products, which brings the total annuitized products to about 70% and we had a small reduction of $5 billion in net new assets although the second quarter because of tax payments tends to be a slightly more difficult quarter for us.

The second point I want to make is that we have a record level of liquidity; $92 billion in our liquidity pool, almost all cash and cash equivalents almost all in our parent company. Just to give you an idea of $92 billion that’s up from $82 billion at the end of the first quarter, up from $79 billion at the end of the year. That $92 billion if you compare it to our commercial paper outstanding we have $8 billion in commercial paper outstanding. If you compare $92 billion to our prime broker free credit balances, we have $14 billion of prime broker free credit balances. So we are extremely liquid.

A third point I want to make is we have been reducing our risky assets, we’ve been reducing our balance sheet and we have de-risking our positions. We will this quarter report risk weighted assets will be down 27% for this quarter. That’s about $130 billion reduction. Our adjusted assets which are less of a good measure of our risk profile but still a measure people look at will be down 14%.

And in some of the more focused on areas like leverage loans, our leverage loans were down 47% quarter-over-quarter. They are now at a level of $7.5 billion. They’re actually down even more then that percentage wise for the full year, but quarter-over-quarter down 47% to $7.5 billion. Excluding our banks portfolio, so in our trading books, our Alt-A position is down 50% to $1.5 billion. Our sub-prime position is down 30% to $1 billion and our commercial real estate position is down 15% to $17.5 billion and just to give you an idea of that decline in our commercial real estate portfolio we did that with no P&L impact. So those were all done where we carried that inventory.

So the strength of the core franchise, very liquid and reducing risky assets, and shrinking our balance sheet. Next point I want to make is that in spite of this loss for the quarter we likely have in our last two quarters more then replaced the capital that we’ve lost. So at the end of the first quarter we replaced the capital that we lost, at the end of the year we more then replaced the capital that we lost. In this quarter as we have talked about in each of the quarters we analyze what our different options were and we raised capital in the way we thought was the most effective and most advantageous to our shareholders. So we have concluded the sale of our 20% stake in Bloomberg. That transaction which of course was in the papers today, but we both signed and closed that transaction today so that transaction is done. We sold our 20% interest in Bloomberg for $4.425 billion. We’ve also entered into a Letter of Intent to sell a controlling stake in FDS. FDS is a subsidiary that performs administrative type functions for mutual funds, things like sub-accounting and transfer agency type functions.

We are expecting that the total enterprise will be valued in excess of $3.5 billion and we will sell a controlling interest in that. Just to give you an idea what does that mean in terms of our capital ratios, on a pro forma basis taking into account the loss for the quarter and pro forming these two transactions we will have a Tier 1 equity to risk weighted assets of around 9.5% and we will have a total equity to risk weighted assets of around 15%.

Just to benchmark that the Feds’ guideline for total capital to risk weighted assets to be deemed well capitalized is 10%. So we have 15% versus that 10% and 9.5 on a Tier 1 basis. The other comment in terms of capital raising, we have decided that we would not sell any of our BlackRock stake. BlackRock as we’ve always talked about is strategic to us. We in fact with the discussions with BlackRock have broadened and lengthened our distribution agreement with them and we continue to believe that that is a very good and important partnership for us and is working well with us.

Based upon the most recent stock price performance our stake in BlackRock is worth approximately $13 billion. Last point I’ll make before I turn it over to Nelson is we told you at the end of the first quarter that we were going to focus on expenses and that we were going to reduce our headcount by 10% of our non-financial advisor headcount. That was about 4,000 people. We delivered on that promise. We’ve actually reduced our headcount by 4,200 people. We told you at the time that we expected annualized run rate savings of $800 million, the actual annualized run rate savings will be $925 million. We also told you that we expected to save about $600 million in 2008, that number will actually be about $730 million.

So we are trying to be good about delivering on what we promised. So overall in spite of the difficult market and difficult quarter, obviously disappointing results, our core franchise continues to deliver. We are very liquid. We have reduced our risky assets on our balance sheet and will continue to do that. We have continued to replace any capital losses with new capital and actually made our capital [inaudible] better and we will continue to focus on expenses.

With that I’ll turn it over to Nelson.

Nelson Chai

Thanks John, let me take a moment to review our major segments. In Global Markets and Investment Banking second quarter net revenues of negative $5.3 billion were down substantially from prior periods and GMI’s pre-tax loss for the quarter was $8.2 billion. However as we have detailed in attachment eight of our press release excluding write-downs and fair value gains of our debt, GMI adjusted revenues of $4.3 billion during the quarter which represents an 11% increase over first quarter of 2008.

Our FICC businesses, strong performance in our core businesses, rates and currencies, credit trading and commodities were more then offset by losses in credit valuation adjustments. If you turn to attachment six in our release, I will walk you through each of our major exposures starting with the ABS CDOs and related mono line exposures which account for the majority of our write-downs as John mentioned both this quarter and over the last 12 months.

As you can see on the top of attachment six on the super senior ABS CDO front at quarter end our net exposure was approximately $4.2 billion which is comprised of a $20 billion long position and a $16 billion short position. Our net CDO position reflects a $3.5 billion write-down partially offset by an increase in net exposure due to certain hedges deemed ineffective. Given the market environment we remain prudent in our evaluation approach. We are taking into consideration incremental remittance and other data which was negative during the quarter. As a result we increased our average cumulative loss assumptions for this portfolio across most underlying collateral types in the second quarter.

As a result of these losses in our underlying super senior ABS CDO positions the corresponding value of our related hedges increased during the quarter. As I mentioned our total US super senior ABS CDO short position was $16 billion in the second quarter. Of this amount $9.6 billion were with the mono lines and $6 billion were other financial counterparties such as insurance companies and hedge funds. For the ABS CDO hedges we have with the mono lines our credit valuation adjustment was negative $1.4 billion during the quarter which was driven largely by the market observables for the mono lines to which we have exposure.

On average we’ve written down the value of these hedges to approximately $0.30 on the dollar at quarter end. In addition we have hedges in place with the mono lines in asset classes away from CDOs, primarily CMBS, and corporate CLOs. And while the market value declines on these positions we are hedging have been very modest the negative credit valuation adjustment on the related hedges with mono line counterparties was $1.5 billion. Our remaining carrying value on these hedges is $3.6 billion.

As I turn to residential mortgages which are detailed in exhibit seven, the vast majority of our exposure is from US prime mortgages that we have primarily originated from our high net worth First Republic and Global Wealth Management clients. On average these clients have FICO scores in excess of 750, loan to values less then 60% and virtually zero default history. As John mentioned earlier, away from these US prime mortgages our other residential exposures were down in aggregate by 25% with reductions of 29% in sub-prime, 51% in Alt-A and 15% outside the US.

In aggregate the majority of our exposure reduction was driven by asset sales of approximately $2 billion during the quarter. Within both commercial real estate and leveraged finance we remain comfortable with the quality of both of these portfolios but have substantially reduced our net exposure to these asset classes consistent with our overall strategy to reduce risk. In leveraged finance we reduced our exposure by approximately $7 billion in the quarter through sales that were completed at levels on average consistent with our marks at the time of the execution.

In commercial real estate excluding First Republic Bank we reduced our exposures to about $15 billion, down 17% from the first quarter primarily due to sales of whole loan, and conduit exposures in the US and EMEA and again we did sell without taking marks. Finally within our US bank investment securities portfolio we recognized net pre-tax write-downs of $1.7 billion through the income statement during the second quarter of 2008 as the impairment we had previously recorded to other comprehensive income or OCI, was deemed to be other then temporary.

At quarter end our portfolio was $18 billion a reduction of approximately $2 billion from the first quarter of which more then $850 million was from sales and pay-downs. Turing to equity markets, second quarter net revenues of $1.7 billion excluding the fair value gains on our debt was up 45% versus the first quarter of 2008. The strong operating performance was driven by record financing and services revenues which reported double-digit sequentially and year-on-year revenue growth as our businesses benefited from increased flows resulting from the European dividend season during the second quarter.

Also driving equity markets performance was a rebound in our prop trading book which suffered losses during the first quarter and was up materially from the prior year period. Partially offsetting these sequential gains were declines in equity link and our private equity business. Private equity revenues were negatively $184 million for the quarter primarily due to continued price declines on our publically trades investments which we mark-to-market. Investment banking revenues were up nearly 30% sequentially driven by EMEA which generated record revenues in the first half of the year.

Most notably bookrunning for $24 billion rights issued for RBS, the largest equity issuance globally ever. Additionally particular strength came from our merging markets such as Russia, where our first half revenues were more then four times those we generated in all of 2007. While industry wide deal volumes had declined, Merrill Lynch had maintained its strong global position in the second quarter. As John mentioned we are number three in global debt and equity fees and recently named best global M&A house for 2008 by Euro Money.

We continue to engage in active strategic dialogue with clients, advising on industry leading transactions such as the $13 billion Rusal Norilsk deal, the largest ever M&A transaction in Russia and the recently announced $18 billion acquisition of Rohm & Haas by Dow Chemical. Turning to GWM, Global Wealth Management continued to deliver solid performance with quarterly revenues at $3.4 billion, down 7% from the first quarter as performance was impacted by continued market depreciation and persistent market volatility. However pre-tax earnings of $738 million were up 3% and GWM’s margin increased from 20% in the first quarter to 22% in the second quarter despite continued investment in growth initiatives.

Notable highlights for the quarter include $8 billion in net new annuitized inflows, client assets of more then $1.6 trillion, success in [inaudible] our industry leading team of financial advisors and net positive recruiting in our top two quintiles, double-digit revenue and pre-tax growth in First Republic, international FA growth of 11% year-over-year excluding Japan, and the record quarterly revenues in Latin America.

GPC net revenues for the second quarter were $3.2 billion down slightly from the first quarter despite the market volatility reflecting the stability of the client franchise and the significant proportion of recurring revenues. The sequential decline was also impacted by the first quarter gains from the [VISA] IOP. During the quarter net inflows of client assets into annuitized-revenue products was $8 billion. However net new money was negative $5 billion. This represents our first quarter of net new money since the second quarter of 2003 and reflects the seasonal client income tax payments and the merger related departure of a significant institutional retirement client.

We continue to invest in our market leading platforms and increase our FA population which increased by 30 professionals during the quarter. We also continue to realize success in our recruiting efforts particularly in our top two quintiles where we added almost 140 FAs on a net basis. In GIM net revenues were $193 million for the quarter reflecting a 35% decline from the first quarter. Weakness in GIM accounted for almost half of the overall revenue decline in GWM versus the first quarter and a result of lower revenue from equity investments we have in alternative investment management companies.

As I turn to expenses John mentioned our focus on expenses, for the second quarter our operating expenses excluding the restructuring charge were 11% lower then the first quarter of this year and 16% lower then the second quarter of last year. This sequential expense reduction was driven by a previously announced reduction in workforce as well as the absence of expenses related to the accelerated vesting of certain restricted stock that took place in the first quarter. Non-comp costs excluding the restructuring charges did increase 8% year-over-year primarily due to growth in technology and occupancy expense attributable to the First Republic acquisition which happened in early 2007 and infrastructure build-out in Europe which occurred in the back half of 2007.

We remain focused on managing the firm’s expenses to be better in line with the business activity. As John mentioned earlier we exceeded our target headcount reductions and estimate the associated pre-tax cost savings will be approximately $730 million in 2008 and approximately $925 million on an annualized run rate basis. This quarter we are reporting a pre-tax restructuring charge of approximately $445 million.

Our effective tax rate for the quarter was 42.9% a modest increase from last quarter reflecting changes in the geographic mix of our earnings. During the quarter we issued $2.7 of perpetual non-cumulative preferred stock and at quarter end and adjusting for our convertible preferred securities on an if-converted basis, total equity capital was $39.5 million and our adjusted book value per share was $24.94. As John mentioned earlier through the completed sale of our Bloomberg stake and our expected sale the controlling interest in FDS we are continuing to further bolster the firm’s capital base. Pro forma for these sales we expect our adjusted book value per share to be in line with first quarter levels.

Finally we continue to reduce our balance sheet across all key measures. We expect total assets to be down 7% versus the first quarter and below $1 trillion. We expect adjusted assets to be down 14% versus the first quarter resulting in adjusted asset leverage ratios to decline from 16.1x in the first quarter to 14.5x in the second quarter. As John mentioned our risk weighted assets as expected to decline 27% in Q2 and we project our level three assets to decrease approximately 20% for the quarter to approximately 6% of our total asset base.

Let me be clear, we remain focused on continuing to reduce our balance sheet and risk weighted assets in the coming quarters. With that we will open it up to questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of Roger Freeman - Lehman Brothers

Roger Freeman - Lehman Brothers

Can you just help us think about this FDS transaction, so you had $8 billion enterprise value, you’re going to sell a majority stake, how much capital actually on an after-tax basis do you actually expect that to bring in?

John Thain

Its easier to do the Bloomberg one because that’s actually done, so in the case of FDS $3.5 billion is the enterprise value, because it’s a Letter of Intent there are a number of pieces of the transaction that aren’t finalized yet. We will sell a controlling stake, so we’ll sell more than 51%, but the exact percentage hasn’t been totally determined yet. But no matter how much of the actual amount that we sell we do expect to be able to book the entire valuation on the company. So I think for modeling purposes you can simply use the $3.5 billion number although that will not be the exact number, it’ll change around, but that’s a good number just to use for now for your purposes and that’s a pre-tax number too.

Roger Freeman - Lehman Brothers

Could we actually get the Tier 1 and total capital ratio?

John Thain

Pro forma--

Roger Freeman - Lehman Brothers

Not pro forma just the stated numbers.

John Thain

That obviously is not terribly useful because I think you really should look at the pro forma numbers, but as of June 27 the Tier 1 number will be 7.5% and the total capital number will be 12%.

Roger Freeman - Lehman Brothers

Can you just talk about how you think about the capital going forward, first of all can you talk to whether BlackRock is still an asset you would consider selling if necessary, and obviously pro forma your capital ratio do at least on a total ratio basis stack up in the range of your peers, but you still have some pretty sizable exposures here and fairly liquid assets, if you were to need more capital how would you think about that? Would it be asset sales long before selling common equity?

John Thain

Just like we’ve always said and going back to the first of the year we would look at all of our options and decide what we thought made the most sense for the long-term interest of our shareholders. Right now we think we are in a good position, we are well capitalized with 9.5% Tier 1 and 15% total versus risk rated assets, and we also have been able to and will continue to shrink our risk rated assets. So we will look at this really both directions, how much capital do we need and how can we improve our risk rated asset ratios by reducing risky assets but right now we believe that we are in a very comfortable spot in terms of our capital.

Roger Freeman - Lehman Brothers

And the assets you’ve been selling this quarter how much of that have you had to finance to move those assets off the balance sheet and which asset classes would that have been particularly relevant to?

John Thain

The simple answer is almost all of the sales were for cash and then I’ll give you what the exceptions were. On the leveraged loans we did two trades of approximately $3 billion where we did provide financing and that financing was a very significant haircut so one of the trades it was a 50% haircut so we provided 50% leverage and the other trade it was a little bit mixed because it was different between bonds and bank loans but on the bonds we also provided 50% leverage and on the bank loans we provided 75% leverage. Those are the only two trades out of the leverage loan book that had any leverage to them.

In the commercial sale, again it was almost all for cash, there was a small amount that was financed but also on totally commercial terms. So almost all the asset sales were for cash.

Roger Freeman - Lehman Brothers

Are the Bloomberg and FDS sales, are you financing those?

John Thain

We are financing the Bloomberg sale and we will certainly, although we have determined the total amount yet, finance a significant part of the FDS sale.

Roger Freeman – Lehman Brothers

The sales that you’ve done how important have they been to establishing market based pricing for the level threes, are they coming down a lot, are we going to see flow backs from three to twos because of these sales during the quarter?

John Thain

Yes.

Operator

Your next question comes from the line of Prashant Bhatia – Citigroup

Prashant Bhatia – Citigroup

Just on the gross long CDO exposure that was down about $6 billion, can you just breakout what drove that decline and the same on the short side, that was down about $4 billion?

John Thain

Are you asking why they’re different or are you asking--?

Prashant Bhatia – Citigroup

No I’m trying to understand on a gross basis just the components of the $6 billion decline for example, a certain amount was written down, a certain amount was sold or what drove on a gross basis the $6 billion decline?

John Thain

It is mostly markdowns. There is a little bit of sales, but it’s mostly markdowns.

Prashant Bhatia – Citigroup

And on the short side, it’s just the ineffectiveness basically on the $4 billion?

John Thain

Yes, the single biggest impact was the ineffectiveness of one of the hedges.

Prashant Bhatia – Citigroup

You had said the, on an if-converted basis, you’re going to be on book value per share at about the same level as the first quarter?

Nelson Chai

That’s correct.

Prashant Bhatia – Citigroup

But don’t the sales add something like $6 billion in after-tax proceeds?

Nelson Chai

Well first of all we are projecting what they are and so we are mindful because we are still negotiating through the details of the FDS contract to give out numbers, understanding how these are used, and so I think we were more comfortable saying they are in line and obviously as we get closer to it we will share that information but we are comfortable saying today that pro forma we’ll be in line with first quarter.

Prashant Bhatia – Citigroup

And you’re talking about book value on an if- converted basis?

Nelson Chai

Yes, so the first quarter if converted basis book value per share was $28.93.

Prashant Bhatia – Citigroup

Okay, you’re looking at the $28.93.

Nelson Chai

Yes.

Prashant Bhatia – Citigroup

In terms of you said you adjusted the cumulative loss assumptions on the CDO side, did you adjust them down two our up two?

John Thain

I want to caveat looking at that, there’s two things that are happening with our CDOs, on is that the sub-prime component of what’s inside of the CDOs is becoming less important because its being written down so much. So the answer to your question is the range of cume losses on the sub-prime range between 19% and 26%. Those are cume losses. But those are becoming less relevant because we are now looking through the CDO structure to the actual assets that underline the CDO and although we run a cash flow model, we ascribe no value to the CDO structure at this time.

So we’re simply looking through the CDO into the assets themselves. And actually there was more transparency in a number of the assets that are inside of the CDO particularly the Alt-As and so the value that we carry them now at reflects to the best of our ability that we can get the value of the underlying pieces. It is actually I think the way that CDOs are going to be looked at going forward is if you could collapse them and of course most of them you can’t yet, but if you could collapse them, what’s the underlying collateral actually worth that’s inside of them. And that’s how we’re looking at them.

Prashant Bhatia – Citigroup

Does that then on a go forward basis make looking at things like the ABX index less relevant?

John Thain

The answer is yes absolutely and as we’ve said before we do not use the index to hedge these and so there would be huge tracking error between the ABX and what I just said in terms of the collateral value.

Prashant Bhatia – Citigroup

In terms of the write-downs that you’ve taken on the mono lines it clearly looks like they were down graded and you continued to take the write-downs, do you have a view, I think your credit valuation adjustments about $6 billion what portion of that might you get back over time if these entities just simply ran off, would you be able to get something back over time do you think?

John Thain

It’s very dependent on which of the mono lines. And so I’ll use the best example, I think in the case of MBIA I think it is very unlikely that they will actually default because it’s not in their interest to do that. I think they will simply go into a run off mode and they will simply keep collecting their payments and making their payments and they’ll live for years and year. And so in that particular case it’ll really be a question of over multiple year period of time how long can they continue to make their payment and what’s the actual result on the assets which of course nobody knows. So that’s probably the best case for recovery. On the other ones I think it’s much more problematic and I think it’s much more difficult to expect—the other ones that we have because we don’t have [inaudible] so on the other ones that are in much worse shape, I think it’s much less likely we’d get anything back.

Operator

Your next question comes from the line of Meredith Whitney – Oppenheimer

Meredith Whitney – Oppenheimer

The earnings impact of the sales of Bloomberg and FDS in terms of operating earnings so what we net out of perspective earnings?

John Thain

This actually goes a little bit to why did we pick these assets. In the case of Bloomberg although its obviously a very valuable asset the way we accounted for it, we only picked up in the income the actual distributions that we made to us. And so based upon our projections for those distributions and the income that we will receive on the loan we believe that’s basically a wash. So we don’t think it will have any impact.

Meredith Whitney – Oppenheimer

And then on FDS?

John Thain

In the case of FDS it’s a little bit harder to answer that because we haven’t determined exactly what percentage of it we will continue to own. But because FDS itself is a relatively small revenue number the total is only 3% of GWM revenues, when we figure out what our percentage we’re going to keep and then when we add back whatever amount we finance with the amount of the income would be on the loan, we don’t think it’s a material impact on our revenues or income.

Meredith Whitney – Oppenheimer

Given the fact that this is the fourth quarter of material write-down for the company and just knowing what you’re reputation is I can imagine you’re incredibly frustrated and why not at this point be the first to purge assets and just get it over with and if that means raising capital that means raising capital, but you bring people in you want to be long-term shareholders, stock go down, just start fresh, what’s the push-back on that, it seems like the most basic question out there if you could just elaborate on that.

John Thain

I agree with you on the frustration part, first of all we are selling assets and so we have sold a lot of assets and we kind of went through what the different ones were. To cut your leverage loan book in half is not the easiest thing to do in this environment. To cut our Alt-A positions down as much as we have and our sub-prime positions. The one place that there hasn’t been a trade yet is in the CDO market and we’re—your question is a very leading one and that would certainly be something that we would be hopeful that we could do.

Meredith Whitney – Oppenheimer

Could you set a market by hitting whatever cash bid there is out there and just get it over with?

John Thain

No I don’t think we want to do dumb things and so we’ve been I think pretty balanced in terms of what we sold and at what prices we sold them. And so we have not simply liquidated stuff at any price we could get. At some point some of the return profiles that people want you probably wouldn’t want us to sell the assets. So I think we will continue to sell assets but in a way that makes sense from generating returns to our shareholders.

Operator

Your next question comes from the line of Patrick Pinschmidt – Morgan Stanley

Patrick Pinschmidt – Morgan Stanley

On the Tier 1 capital ratio you’re a little bit lower then your peers, would you expect to move that ratio up a few percentage points over the next two quarters is that the plan? What have been your conversations with the regulators and some of the credit rating agencies on that front?

John Thain

In this environment for us to be around 10% is going to be fine given the mix of our business on Tier 1. Remember that our business, first of all half of our business is the wealth management business which really doesn’t have much of any risk to it at all, and then the other half we are continuing to shrink. There’s two other ways about how this ratio is calculated, one is because of the losses we have a very large deferred tax asset and because of the way the calculation works we’re not allowed to include all of that deferred tax asset into this calculation. But the deferred tax asset is infinite so it lasts forever. So we will eventually be able to use it. If we actually added back all of the deferred tax assets our Tier 1 ratio would be around 11%. So I think we’re in a comfortable spot right now. It is a little bit lower then some of our competitors but also some of our competitors have very different businesses.

Patrick Pinschmidt – Morgan Stanley

In terms of if you do encounter another scenario where you have to take more write-downs and you need more capital what are your options in terms of potential asset sales? Presumably Bloomberg and FDS are the two big ones that can move the needle and BlackRock you’ve said you want to keep, what else is out there? Is there anything meaningful that could—so you don’t have to go out and raise common equity?

John Thain

I’m going to repeat what I said before, we have consistently—first of all we’ve consistently for the last couple of quarters replaced any losses with new capital, actually more then that and second of all we’ve said we will look at all of our different options. We a trillion dollar balance sheet, there are in fact other options. You’ve never heard of FDS and there are other options on our balance sheet.

Patrick Pinschmidt – Morgan Stanley

Can you update us on the long-term debt funding profile? I think back in the first quarter you said you had something like north of $40 billion maturing in the back half of the year?

Nelson Chai

Right now as you know as John mentioned we have $92 billion in our excess liquidity pool, and this covers the maturities over the next year by about 1.25x. If you look at the debt maturities that are going to come, the good news for us is that over the next its going to substantially decline in terms of what our funding needs are as we go through the next couple of quarters. As you know we were very active in the first half of the year particularly in April, where we issued $37 billion in the first half of 2008, and you’ll see us continue to opportunistically look for opportunities to go to the market if you will. As John mentioned we have been very mindful of our leverage out there and of our debt. You heard John talk both about both our CP as well as our free credit balances so I think we are doing a very—we’re spending a lot of time, and again [Eric Heaton] deserves a lot of credit who’s our Treasurer, for really looking both at our funding obligations and our exposures in this marketplace.

Operator

Your next question comes from the line of Glenn Schorr – UBS

Glenn Schorr – UBS

On the Bloomberg I thought it was thought to be a good cash flower and a good yield and a good earner for Merrill, can you just help me and re-explain why there’s no material impact to revenues/earnings?

John Thain

As I said we only pick up into income the actual distributions and Michael recapped his company a year or so ago, and so there is a lot more leverage on it now and they had very significant distributions when they did that. But the combination of the leverage on it based upon our expectations would have significantly reduced the distributions at least in the near-term.

Glenn Schorr – UBS

You provide us with the net exposures across all the asset classes and I think only in the sub-prime ABS CDOs did we get the gross exposures, is there anything qualitative because obviously you’d give it to us if you wanted to, that you can help us with on the difference between gross and net in the other material asset classes?

John Thain

The simple answer is I don’t there really is any difference between gross and net in any place other then the CDOs. There really aren’t because there aren’t any leverage loans, there aren’t any in commercial mortgages, the only place there would be anything like that would be in our trading books and that’s not really what you’re asking, you’re asking for our assets.

Glenn Schorr – UBS

I know my first thought has to be wrong so help me because when I think of no difference between gross and net I think of un-hedged but that can’t be right, right?

John Thain

Well when you say that, the mortgage related assets that we’re carrying in our long positions are not in fact hedged, so for instance when you look at our Alt-A position it’s not hedged with anything.

Glenn Schorr – UBS

And the same comment on commercial?

John Thain

Our commercial book, they really don’t hedge that in the way that you’re asking it because you can’t really short commercial, our commercial book for the most part not like CMBS, they’re not securities. So they are actual loans and the only way you can really hedge, you can’t really short them, so the only way you can really hedge them would be to [CMDX] and we think there’s too much basis risk in that. So that portfolio is a much more like an investment portfolio and actually one of the things we’re doing is we’re moving that into a third party fund format for that exact reason. So we raised an Asia Pacific real estate fund, that fund is going to close at about $2.8 billion and we will move a significant portion of the securities into that. So far we’ve contributed about $1.5 billion and those just go in there as either loans or equity investments. But they aren’t hedged in the sense of—because they’re not trading books.

Glenn Schorr – UBS

I’ve gotten some similar comments on the loan side, now when the assets move in they moved in at whatever last mark was or a third party service, I’m assuming that’s part of the sales that went this quarter, the $3 billion reduction in the commercial book this quarter?

John Thain

They generally go in at cost plus some carry. So we get some carry but basically they go in at cost. You can’t put them in it—they have to be at market [value] so they’re not—you can’t put them in if they had losses in them.

Glenn Schorr – UBS

If you start out with your $21.1 billion of common stock equity is that the home of the other $4.7 billion of the OCI and any tax deferred asset, because the tax deferred asset that’s big right, its like $12 billion or $13 billion? How much do I need to care that that’s not like really a cash number, that there’s tax deferred assets and things like that that are not as tangible.

Nelson Chai

We’ll come back to you on that one; we’ll take you offline on that one and work through that.

John Thain

The OCI is a deduct, its already deducted out of that number.

Operator

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

William Tanona - Goldman Sachs

Just in terms of the book value, obviously its $21.43 now but if you were to adjust it for the sale of both Bloomberg and FDS what would be the actual book value?

John Thain

That’s what Nelson was saying, he was hedging it a bit because of the calculation, for us to calculate the number we have to make an assumption about the after-tax gain on FDS which we’re trying to not tell you exactly what that is so that’s why he said it was inline with what it would have been at the end of the first quarter.

William Tanona - Goldman Sachs

I guess I was just confused when the conversation, when he was talking if converted I thought he was talking about the mandatory converts being--

John Thain

We do do that, but the number he used for the first quarter also had the mandatory’s converted. So your $21.43 if you convert it to mandatory it’s like $24.94.

William Tanona - Goldman Sachs

And then if we were to add in the Bloomberg and FDS stake what would be the total pro forma if converted book value?

John Thain

Which we’re trying not to give you the exact number, but go look at what it was at the end of the first quarter. That will give you a good guide.

William Tanona - Goldman Sachs

In terms of the hedge ineffectiveness obviously the last couple of quarters we’ve seen some hedge ineffectiveness on the ABS CDOs and even though you’ve written things down we’ve still seen the overall value increase after those write-downs because of the ineffectiveness, what exactly are you using to hedge that portfolio and is there maturities on those things and we have to start thinking about the gross exposure more and more as time goes on with that hedging?

John Thain

There are three kinds of hedges; there are the hedges with very high credit quality counter parties like big insurance companies. I’ll use the gross side that number is about on the long side about $8 billion. Then they are the hedges with the mono lines which although obviously some are better then other ones, the hedges still create the credit value adjustments. And then the third pieces there are some complicated structured hedges which is the main thing that became ineffective and the reason was because there was a complicated structured hedge that had a collateralization provision in it but the mark-to-market loss exceeded the collateral and so basically we don’t get credit for it after that amount.

William Tanona - Goldman Sachs

What’s kind of the value of those complicated hedges?

John Thain

The easiest answer to that number is the $1.3 billion that we show in our table on exhibit six. That’s what’s causing the increase in the net exposure.

William Tanona - Goldman Sachs

I guess in terms of you guys were obviously a big underwriter in both cash and synthetic CDOs, what did you invest the underlying cash collateral in the synthetic CDOs and what type of instruments and how are those reported on the financial statements?

John Thain

First of all I take exception to the you guys comment. I did not create any of these CDOs. I think we its probably specific on the deals because whenever there’s one of the synthetics there will be a whole series of requirements as to what the collateral has to look like--in general, when you create a synthetic it will have a whole bunch of criteria about what the collateral has to look like, it had to satisfy a whole series of rating agency test, it had all kinds of diversification requirements in it and I think it’s probably not going to be easy or probably not very useful to answer your question kind of generically because my guess is that it’ll be totally dependent on each individual security. So I think that each one would be different.

Nelson Chai

It would be captured in the contractual agreement [inaudible] line on our balance sheet but I don’t know just by looking at it if you will be able to answer your question.

John Thain

Is there a particular type of risk you’re trying to get at?

William Tanona - Goldman Sachs

Just understanding that if the collateral was invested in treasuries or some type of safe security or could that underlying collateral also be invested in higher risk stuff and just trying to understand exactly what the underlying collateral was invested in and to try to gauge the risk of that.

John Thain

I don’t think—if you’re thinking there’s a risk or a value there, I think neither one actually exists but we should do this offline because we’d have to take a very—we’ll take a specific synthetic and we’ll go through with you what it was actually invested in. I think that’s the best way for you to get an answer to that.

Operator

Your next question comes from the line of David Trone – Fox-Pitt, Kelton

David Trone – Fox-Pitt, Kelton

I know you gave us the book value answer with respect to your 1Q08 comment but I wanted to poke around the details a little bit, could you tell us the carrying value on those two properties?

Nelson Chai

On Bloomberg and FDS? Zero, effectively zero.

David Trone – Fox-Pitt, Kelton

And how should we think about the tax treatment under the circumstances?

John Thain

You should assume a tax rate and just apply to it—we’re not going to actually help you on the tax rate. You just have to use one.

David Trone – Fox-Pitt, Kelton

You mentioned the 3.5 is enterprise what is the, can you tell us the tangible equity?

Nelson Chai

It was zero on Bloomberg and it’s about $500 million on FDS.

David Trone – Fox-Pitt, Kelton

If by chance you had to do an equity capital raise, the [inaudible] price reset would be about $2 billion?

John Thain

Two things about that, one is its obviously very dependent on the share price and second is you shouldn’t assume that we would necessarily have to pay them whatever the contractual terms were since that expires in less than six months.

David Trone – Fox-Pitt, Kelton

On the auction rate security side, auction rates, we’ve seen some other retail oriented institutions step up and help customers how do you think about that?

John Thain

We definitely have been helping our customers. We’ve been helping them mostly by getting the issuers to refinance them. We started off with about 22 billion inside of our system. The last time I checked were we down to about 13 billion so we’ve already gotten over 40% of them refinanced. Everybody got all their money back. So we’re going to continue to do that.

David Trone – Fox-Pitt, Kelton

You mentioned the commercial real estate sales, I think you said you had no write-downs, can you give us a little more color on how that came to pass?

John Thain

They were very good assets and we could sell them where we carried them.

Operator

Your final question comes from the line of Jeffery Harte – Sandler O’Neill

Jeffery Harte – Sandler O’Neill

On the capital side, shortly after you announced your earnings Moody’s down graded your senior long-term debt, does that one notch down grade have some kind of an impact on the amount of collateral you’ll have to post?

John Thain

No, none. And by the way they also made our ratings stable which was a very good thing.

Jeffery Harte – Sandler O’Neill

And more specifically in the retail side, what as a manager can you or are you doing to kind of keep morale up when the stock prices coming down and losses are building and it’s a tough environment out there anyway, how big of a challenge is that and what can you do to help it?

John Thain

Well first of all that’s part of my job. I have for instance a global town hall session tomorrow morning to answer questions for the entire employee base. I think that our employee base understands that these losses are all coming from legacy positions that the current management team and them had nothing to do with. And so the fact that our core franchise is so strong, the fact that we can earn $7.5 billion in revenues and almost $2 billion pre-tax I think that is what motivates them because that’s what they’re contributing and these legacy assets and legacy losses we have to deal with. But I think they’re excited about how well they’re doing.

Operator

At this time I will turn the call over the Sara Furber for closing remarks.

Sara Furber

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

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Source: Merrill Lynch & Co., Inc. F2Q08 (Qtr End 06/27/08) Earnings Call Transcript
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