Bank of America Corporation — Q2 2010 Form 10-Q
Reporting period: Three and six months ended June 30, 2010; filed August 6, 2010. Unaudited consolidated results. The company is a diversified U.S. and international financial services group. Amounts below are in U.S. dollars; “bn” means billion. Comparisons are with the corresponding 2009 period unless noted.
Financial performance and position
| Metric | Q2 2010 | Q2 2009 | Six months 2010 | Six months 2009 |
|---|---|---|---|---|
| Revenue, net of interest expense (GAAP) | $29.2bn | $32.8bn | $61.1bn | $68.5bn |
| Revenue, fully taxable-equivalent (FTE; non-GAAP) | $29.5bn | $33.1bn | $61.7bn | $69.2bn |
| Net interest income (GAAP) | $12.9bn | $11.6bn | $26.6bn | $24.1bn |
| Net income | $3.1bn | $3.2bn | $6.3bn | $7.5bn |
| Net income applicable to common shareholders | $2.8bn | $2.4bn | $5.6bn | $5.2bn |
| Diluted EPS | $0.27 | $0.33 | $0.55 | $0.75 |
| Provision for credit losses | $8.1bn | $13.4bn | $17.9bn | $26.8bn |
| Noninterest expense | $17.3bn | $17.0bn | $35.0bn | $34.0bn |
- Margins and returns: Q2 FTE net interest yield was 2.77% versus 2.64%; the FTE efficiency ratio was 58.58% versus 51.44%. Return on average assets was 0.50% versus 0.53%; return on average tangible shareholders’ equity was 8.98% versus 8.86%. The FTE yield, efficiency ratio and tangible-equity return are non-GAAP measures.
- Balance sheet at June 30: Assets were $2.364tn, up from $2.223tn at December 31, 2009. Loans and leases were $956.2bn, up from $900.1bn; deposits were $974.5bn, down from $991.6bn. Long-term debt was $490.1bn, up from $438.5bn; short-term borrowings were $73.4bn, versus $69.5bn.
- Credit quality: The loan and lease allowance was $45.3bn, or 4.75% of loans, versus $37.2bn, or 4.16%, at year-end. Q2 net charge-offs were $9.6bn (3.98% annualized), versus $8.7bn (3.64%); first-half net charge-offs were $20.4bn (4.21%), versus $15.6bn (3.24%). Nonperforming loans and leases were $33.2bn, compared with $33.5bn at year-end; nonperforming loans, leases and foreclosed properties totaled $35.7bn.
- Cash flow, first half: Operating activities provided $39.4bn, compared with $74.8bn. Investing activities used $20.1bn, versus providing $173.9bn; financing activities provided $10.5bn, versus using $141.1bn. Cash and cash equivalents rose $29.7bn to $151.0bn. These banking cash-flow totals are affected by large securities, lending and funding movements.
- Capital and liquidity: At June 30, Tier 1 common, Tier 1, total capital and Tier 1 leverage ratios were 8.01%, 10.67%, 14.77% and 6.69%, respectively. Global excess liquidity sources were $293bn, up from $214bn at year-end; parent-company sources were $96bn. Parent-company “Time to Required Funding” was 22 months against a 21-month minimum target. The company reported it was “well-capitalized” under regulatory requirements.
Material changes versus comparable periods
- FTE revenue declined 11% in both Q2 and the first half. Lower equity investment income, mortgage banking income and trading profits were major Q2 drivers; first-half results also reflected lower securities-sale gains and card income.
- Net income fell slightly in Q2 and 16% for the first half, despite higher net interest income and lower credit-loss provisions. A higher tax expense, including comparison with a tax benefit in Q2 2009, and lower noninterest income contributed. Average diluted common shares rose to 10.0bn in Q2 from 7.3bn, partly reflecting prior acquisition-related issuance and the 2010 conversion of common-equivalent securities, affecting per-share comparisons.
- Provision expense fell substantially as management cited improved delinquencies, collections, bankruptcies and commercial borrower credit profiles. However, net charge-offs increased year over year, in part because newly consolidated securitized loans and regulatory-required write-downs of certain modified real-estate loans affected reported measures.
- Noninterest expense increased, including higher personnel costs, professional fees and litigation costs; merger and restructuring charges declined. The Q2 personnel expense included a $425m U.K. payroll tax on certain bonuses.
- On January 1, 2010, new consolidation guidance added $100.4bn of assets and $106.7bn of liabilities and resulted in a $6.2bn after-tax charge to retained earnings, principally related to increased loan-loss allowances. The initial balance-sheet entry did not affect earnings on the adoption date. It materially changed reported balances and complicates comparisons; Global Card Services’ 2009 segment results are presented on a managed basis for comparison.
- Q2 segment results were mixed: Global Card Services returned to profit ($806m versus a $1.6bn loss), mainly as credit costs fell; Home Loans & Insurance reported a $1.5bn loss versus a $726m loss; Global Banking & Markets’ net income declined to $927m from $3.9bn; Global Commercial Banking earned $790m versus a $64m loss; and Deposits earned $665m versus $534m.
Outlook, risks, contingencies and unusual items
- No broad earnings guidance: The filing provides no clear full-year earnings or revenue guidance. Management described the recovery as uneven and fragile, with elevated unemployment, household debt and real-estate stress; customer deleveraging and weak loan demand were weighing on loan growth and net interest income.
- Financial Reform Act, enacted July 21, 2010: Management estimated 2010 debit-card revenue of about $2.9bn and, subject to rulemaking and before mitigation, annualized revenue loss of $1.8bn–$2.3bn beginning in Q3 2011. The company expected a nondeductible, noncash Global Card Services goodwill impairment of $7bn–$10bn in Q3 2010. Management said the charge would not affect reported Tier 1 or tangible equity ratios. These estimates were uncertain and did not include all potential mitigation.
- Other regulatory effects: Management estimated the 2010 after-tax revenue impact of CARD Act provisions at about $1bn and the impact of Regulation E/overdraft policy changes at about $1bn. A U.K. corporate tax-rate reduction was expected to produce an approximately $400m Q3 tax charge from revaluing deferred tax assets. The $425m U.K. bonus payroll tax was recorded in Q2 expense.
- Capital commitment and asset sales: Following approval to repay TARP preferred stock, the company had agreed to generate $3bn of additional equity through approved net asset sales. The Federal Reserve extended the deadline to December 31, 2010. The company reported $10bn of gross asset-sale proceeds and about $1.9bn of after-tax accounting gains toward the target; any shortfall would require a corresponding common-equity raise. Sales included Itaú Unibanco, MasterCard shares and Columbia’s long-term asset-management business; the company also agreed to sell its Santander stake and announced an intention to sell Balboa Insurance.
- Mortgage representations and warranties: The recorded liability was $3.9bn, versus $3.5bn at year-end; related expense was $1.2bn in Q2 and $1.8bn for the first half. Unresolved repurchase requests related to loans with $11.1bn unpaid principal, including $5.6bn from the GSEs and $4.0bn from monolines. The company said some monoline claims could not be reasonably estimated and may not be covered by a recorded liability.
- Litigation: For disclosed matters where loss was considered reasonably possible and estimable, management’s aggregate estimated range was $250m–$1.4bn. Management did not expect pending litigation and regulatory matters to materially harm consolidated financial position or liquidity, but cautioned that adverse outcomes could materially affect results or cash flows in a particular period. Litigation and regulatory exposures include mortgage-related claims and other proceedings.
- Other significant items: Q2 sales and securitizations reduced the carrying value of non-agency RMBS by $5.2bn and produced $711m of net losses; management said the remaining portfolio’s credit quality improved. The company recorded a $428m impairment on the planned Santander sale, a $440m pre-tax gain on MasterCard shares and a $1.2bn pre-tax gain on Itaú Unibanco. It also recorded a $163m pre-tax loss on agreements to sell private-equity fund exposure.
Most important facts for investors to verify
- Whether credit trends continue to improve and whether charge-offs, delinquencies, nonperforming assets and allowance adequacy support management’s reserve assumptions.
- The final debit-interchange rules, actual card revenue impact and mitigation, and whether the anticipated $7bn–$10bn goodwill impairment is recorded as estimated.
- Further mortgage repurchase demands, actual defect rates, the adequacy of the $3.9bn liability and the potential exposure not reasonably estimable, particularly for monoline claims.
- Whether the $3bn asset-sale equity target is met by December 31, 2010, or a common-equity raise is required; also assess the effects of asset disposals on recurring earnings.
- Capital and liquidity after regulatory changes, ratings actions and any funding pressure; distinguish parent-company liquidity from liquidity held in bank subsidiaries that may not be freely transferable.
- How much of reported revenue and balance-sheet growth reflects underlying business performance versus VIE consolidation, valuation adjustments, asset sales and other nonrecurring items.