Bank of America Corporation — Q2 2014 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2014. Bank of America is a diversified U.S. and international financial services company with five reportable business segments. At quarter-end it reported $2.17 trillion in assets and approximately 233,000 full-time equivalent employees.
Financial performance and position
Dollars in billions, except per-share amounts and ratios. Revenue figures below are GAAP unless identified as fully taxable-equivalent (FTE).
| Metric | Q2 2014 | Q2 2013 | Six months 2014 | Six months 2013 |
|---|---|---|---|---|
| Revenue, net of interest expense | $21.75 | $22.73 | $44.31 | $45.92 |
| Net income | $2.29 | $4.01 | $2.02 | $5.50 |
| Diluted EPS | $0.19 | $0.32 | $0.14 | $0.42 |
| Net interest income, FTE | $10.23 | $10.77 | $20.51 | $21.65 |
| Provision for credit losses | $0.41 | $1.21 | $1.42 | $2.92 |
| Noninterest expense | $18.54 | $16.02 | $40.78 | $35.52 |
| Net charge-offs | $1.07 | $2.11 | $2.46 | $4.63 |
- Profitability: Q2 return on average assets was 0.42%, versus 0.74% a year earlier; the FTE efficiency ratio was 84.43%, versus 69.80%. The first-half FTE efficiency ratio was 91.17%, versus 76.62%. These FTE-based measures are non-GAAP.
- Credit quality: The annualized Q2 net charge-off ratio improved to 0.48% from 0.94%. Nonperforming loans, leases and foreclosed properties were $15.3 billion at June 30, down from $21.3 billion at December 31, 2013. The allowance for loan and lease losses was $15.8 billion, or 1.75% of loans, compared with $17.4 billion, or 1.90%, at year-end.
- Balance sheet and debt: Total assets were $2.17 trillion, loans and leases $911.9 billion, deposits $1.134 trillion, long-term debt $257.1 billion, and shareholders’ equity $237.4 billion. Deposits increased 1.3% from year-end; loans declined 1.8%.
- Capital: Under Basel 3 Standardized-Transition reporting, common equity Tier 1 was 12.0%, Tier 1 capital 12.5%, total capital 15.3%, and Tier 1 leverage 7.7%. Management estimated fully phased-in common equity Tier 1 ratios of 9.5% under the Standardized approach and 9.9% under the Advanced approach; these estimates depend on regulatory interpretations and, for the Advanced approach, model approvals.
- Liquidity: Global Excess Liquidity Sources were $431 billion, up from $376 billion at December 31, 2013. Parent-company sources were $92 billion. Parent-company Time to Required Funding was 38 months; this measure includes an $8.6 billion BNY Mellon Settlement liability whose payment timing was uncertain.
- Cash flow, six months: Operating activities provided $27.5 billion, versus $72.6 billion in 2013; investing activities used $43.8 billion, versus $2.3 billion; financing activities provided $37.7 billion, versus using $80.1 billion. Cash and cash equivalents increased $21.6 billion to $152.9 billion.
Changes versus comparable periods
- Q2 GAAP revenue declined about 4%, while net income fell about 43%; first-half revenue declined about 4% and net income about 63% year over year.
- Litigation expense was the principal unusual cost: $4.0 billion in Q2 and $10.0 billion in the first half, compared with $471 million and $2.7 billion, respectively, in 2013. The increase primarily reflected legacy mortgage-related matters and reserves.
- Credit costs improved materially: the provision fell to $411 million in Q2 from $1.21 billion, and net charge-offs declined. Management attributed improvement to stronger home prices, lower consumer delinquencies and broader portfolio improvement; commercial provisions increased as reserves were raised.
- FTE net interest income declined 5% in Q2 and 5% in the first half. Management cited market-related securities premium amortization, lower consumer balances and yields, and lower trading-related net interest income.
- Mortgage banking income declined to $527 million in Q2 from $1.18 billion, reflecting lower production and servicing income. First-mortgage originations in Consumer Real Estate Services were $8.5 billion in Q2, down 59% year over year.
- Segment results were mixed. Consumer & Business Banking earned $1.8 billion, up 29%; Global Markets earned $1.1 billion, up 14%; Consumer Real Estate Services recorded a $2.8 billion loss, versus a $930 million loss, primarily due to litigation expense and weaker mortgage income.
Outlook, management commentary, risks and unusual items
- Management expected second-half 2014 net interest income to improve modestly from Q2 levels, excluding market-related adjustments. It expected modest further improvement in net charge-offs if economic and asset-quality trends continued, and reserve releases to decline modestly.
- Project New BAC cost savings were expected to reach $2 billion per quarter in Q4 2014, earlier than the prior mid-2015 target. The separate Legacy Assets & Servicing quarterly expense goal of $1.1 billion could be delayed to Q1 2015 because of mortgage-program compliance and governance requirements.
- Management expected an approximately 31% effective tax rate for the remainder of 2014, absent unusual items. The six-month reported rate was 4.7%, reflecting discrete tax benefits and other effects.
- Capital actions: After revising previously reported regulatory capital amounts and ratios, the company suspended its planned 2014 capital actions and resubmitted its CCAR materials on May 27. The Federal Reserve response was due by August 10, 2014. Until then, additional capital distributions required Federal Reserve approval; the approved common dividend was $0.01 per share, and additional buybacks were not approved. A Series T preferred-stock amendment increased Tier 1 capital by approximately $2.9 billion.
- Mortgage settlements and contingencies: The March FHFA settlement involved a $9.5 billion payment and receipt of RMBS valued at approximately $3.2 billion, a net cost of $6.3 billion. The BNY Mellon settlement requires an $8.5 billion cash payment and remained subject to appeals and final court approval. The company reported a $12.1 billion representations-and-warranties liability and estimated up to $4.0 billion of reasonably possible loss above that accrual. Separately, management estimated aggregate possible loss of $0–$5.0 billion above accrued liabilities for certain litigation and regulatory matters; this range is not a maximum exposure.
- Subsequent events: On July 15, 2014, after quarter-end, the company agreed to pay AIG $650 million to resolve outstanding RMBS litigation claims; AIG also withdrew its BNY Mellon Settlement objection and participation in appeals. A separate mortgage-insurance settlement with United Guaranty entities was subject to required consents.
- Other significant exposures include ongoing RMBS, mortgage servicing, foreclosure, mortgage-insurance, DOJ and state investigations, and LIBOR, reference-rate and FX inquiries. The filing states that some potential servicing, securities-law, fraud and other claims cannot be reasonably estimated and could be material.
- Regulatory and market risks include Basel 3 implementation, proposed liquidity and supplementary leverage requirements, potential rule changes, possible credit-rating downgrades, higher rates, operational and cyber risks, and geopolitical or economic stress in non-U.S. markets. Fitch revised its outlook to negative; S&P’s outlook was negative, while Moody’s outlook was stable.
Most important facts for investors to verify
- How much of future earnings and capital could be affected by additional mortgage litigation, regulatory matters and settlements, beyond recorded reserves and disclosed loss ranges.
- Whether the BNY Mellon Settlement receives final court approval and whether the AIG and United Guaranty settlements are completed on the stated terms and required consents are obtained.
- The outcome of the Federal Reserve’s review of the revised CCAR submission and the resulting limits on buybacks and other capital distributions.
- Whether improving credit quality and lower charge-offs persist, and whether mortgage runoff, weaker originations and securities premium amortization continue to pressure net interest income and revenue.
- Whether management achieves the stated cost-savings targets while meeting mortgage-servicing and regulatory requirements; reported expense and earnings include unusually high litigation charges.