Business context and reporting period
Bank of America Corporation’s unaudited Form 10-Q covers the quarter and six months ended June 30, 2016. The diversified U.S. and international bank reported approximately $2.2 trillion in assets and 211,000 full-time equivalent employees. Effective April 1, it replaced its five-segment presentation with four segments—Consumer Banking, Global Wealth & Investment Management (GWIM), Global Banking and Global Markets—with legacy and other activities in All Other. Prior periods were reclassified.
Financial performance and position
| Metric | Q2 2016 | Q2 2015 | Six months 2016 | Six months 2015 |
|---|---|---|---|---|
| Revenue, net of interest expense | $20.4B | $22.0B | $39.9B | $42.9B |
| Net income | $4.2B | $5.1B | $6.9B | $8.2B |
| Diluted EPS | $0.36 | $0.43 | $0.56 | $0.68 |
| Net interest income | $9.2B | $10.5B | $18.4B | $19.9B |
| Provision for credit losses | $976M | $780M | $2.0B | $1.5B |
| Noninterest expense | $13.5B | $14.0B | $28.3B | $29.8B |
- Profitability and margins: Q2 return on average assets was 0.78% versus 0.96%; return on average common equity was 6.48% versus 8.42%. The FTE net interest yield fell to 2.03% from 2.37%, and the FTE efficiency ratio worsened to 65.43% from 62.93%. The filing does not provide a conventional net profit margin.
- Cash flow: For the first half, operating activities provided $26.1B, investing activities used $30.5B and financing activities provided $14.0B. Cash and cash equivalents increased $11.9B to $171.2B. These consolidated cash-flow figures reflect banking and securities activity and may be volatile.
- Balance sheet and funding: At June 30, assets were $2.187T, loans and leases $903.2B, deposits $1.216T, long-term debt $229.6B and shareholders’ equity $267.1B. Since year-end 2015, deposits grew 2% and long-term debt declined 3%.
- Capital and liquidity: Fully phased-in Basel 3 Advanced CET1 ratio was 10.5%, with CET1 capital of $161.8B and risk-weighted assets of $1.542T. Fully phased-in supplementary leverage ratio was 6.9%, up from 6.4% at year-end. Global Excess Liquidity Sources were $515B, with parent-company time-to-required funding of 35 months.
- Credit quality: Net charge-offs were $985M in Q2, down from $1.068B; the annualized net charge-off ratio was 0.44% versus 0.49%. Nonperforming loans, leases and foreclosed properties were $8.8B, down from $11.6B a year earlier. Commercial criticized balances and energy-related problem loans increased.
Material changes versus comparable periods
- Q2 revenue declined 7% and net income declined 18% year over year; first-half revenue fell 7% and net income fell 16%. Lower net interest income and noninterest income, plus higher credit-loss provisions, outweighed lower expenses.
- Net interest income included adverse market-related debt-security adjustments of $974M in Q2 and $2.2B for the first half, versus benefits of $669M and $185M in the comparable 2015 periods. Lower long-term rates accelerated premium amortization on mortgage-related securities.
- Q2 noninterest income decreased $310M. Mortgage banking income fell $689M, reflecting less favorable mortgage-servicing-rights (MSR) performance and a current-period representations-and-warranties provision versus a prior-period benefit. Investment and brokerage and investment banking income also declined; trading profits improved in Q2.
- Expense control reduced Q2 noninterest expense by $465M, principally through lower personnel and operating costs. The provision for credit losses increased $196M in Q2; first-half commercial provision rose sharply, mainly from energy-sector reserves.
- By segment, Q2 net income rose at Consumer Banking ($1.7B), GWIM ($722M), Global Banking ($1.5B) and Global Markets ($1.1B). All Other recorded an $815M loss, primarily from adverse debt-security market adjustments and lower mortgage income. First-half Global Banking income was slightly lower, while Global Markets income increased and All Other’s loss widened.
Guidance, risks and unusual items
- Management expected provision expense to approximate net charge-offs for the remainder of 2016, an effective tax rate of approximately 29% absent unusual items, and had a previously announced 2018 annual noninterest expense target of approximately $53B.
- Following Federal Reserve non-objection to the 2016 CCAR plan, the Board authorized $5.0B of common-stock and warrant repurchases over four quarters beginning in Q3 2016. The Board also declared an increase in the quarterly common dividend from $0.05 to $0.075 per share, payable September 23, 2016. Repurchases remain subject to capital, liquidity, market and other conditions.
- Mortgage settlement and exposure: The Corporation paid $8.5B to BNY Mellon in February 2016, reducing its representations-and-warranties liability to $2.7B at June 30 from $11.3B at year-end. Unresolved repurchase claims were $18.3B in notional amount. Management estimated reasonably possible losses of up to $2B above existing accruals; this is not considered a probable loss and excludes certain other mortgage-related claims.
- Other litigation: The estimated aggregate range of possible loss for certain litigation matters was $0–$1.1B above accrued liabilities, where estimable. The filing cautions that actual outcomes may differ and certain matters cannot be estimated. Q2 litigation-related expense was $270M. A $415M SEC resolution concerning broker-dealer customer-protection compliance was previously accrued.
- Energy and international risks: Energy exposure was about 2% of total loans and leases; sustained low oil prices increased criticized exposures, losses and reserves. The U.K. referendum to leave the EU created uncertainty; the Corporation reported $56.3B net U.K. country exposure. Management noted potential impacts to its business, operating model, markets and U.K. deferred tax assets.
- Other contingencies and accounting: The U.K. proposed corporate tax changes, if enacted, could trigger an estimated $350M tax charge from remeasurement of deferred tax assets. The PPI claims reserve was $246M, with additional expense possible but not reasonably estimable. New expected-credit-loss accounting is scheduled for 2020; the Corporation expected an increase in credit-loss allowances and a negative retained-earnings adjustment, with impact still under evaluation.
- Interest-rate sensitivity: Management described the banking book as asset-sensitive. Its estimated pretax 12-month net interest income impact was +$7.5B for an instantaneous +100 bps parallel shift and −$5.1B for a −50 bps shift. These are scenario estimates, not forecasts, and depend on assumptions including deposit behavior.
Most important facts for investors to verify
- Whether the large negative debt-security premium-amortization adjustments persist, and how rates and mortgage prepayments affect net interest income, MSRs and capital.
- Whether energy-sector credit deterioration leads to further criticized loans, charge-offs, provisions or allowance increases.
- The ultimate cost and timing of unresolved mortgage repurchase, servicing, litigation and regulatory matters relative to recorded reserves and disclosed possible-loss ranges.
- Execution of the $5B repurchase plan, the higher dividend, and the effect of distributions on capital and liquidity buffers.
- How the U.K. referendum, proposed U.K. tax changes and future regulatory capital and liquidity rules affect earnings, operations and deferred tax asset realization.