BANK OF AMERICA CORP annual report, FY2014

Business context and reporting period

Bank of America Corporation’s Form 10-K covers the fiscal year ended December 31, 2014; it was filed February 25, 2015. The bank holding company reported approximately $2.1 trillion in assets and operated through Consumer & Business Banking, Consumer Real Estate Services, Global Wealth & Investment Management, Global Banking, Global Markets and All Other. FIA Card Services merged into Bank of America, N.A. on October 1, 2014. Segment reporting was reorganized effective January 1, 2015, with prior periods to be restated.

Financial performance and key metrics

• Profitability weakened: return on average assets was 0.23% versus 0.53%; return on average tangible common equity was 2.52% versus 6.97%. The efficiency ratio rose to 88.25% from 77.07%.
• Net interest income on a fully taxable-equivalent (FTE, non-GAAP) basis was $40.8 billion, down $2.3 billion; FTE net interest yield fell to 2.25% from 2.37%. Lower loan yields and balances and accelerated securities premium amortization were key factors.
• Credit quality improved: net charge-offs fell to $4.4 billion, or 0.49% of average loans, from $7.9 billion, or 0.87%. Nonperforming loans, leases and foreclosed properties declined to $12.6 billion from $17.8 billion. The year-end loan-loss allowance was $14.4 billion, or 1.65% of loans, versus $17.4 billion, or 1.90%.
• At year-end, assets were $2.105 trillion, loans and leases $881.4 billion, deposits $1.119 trillion, long-term debt $243.1 billion and shareholders’ equity $243.5 billion. Loans fell $46.8 billion while deposits were nearly unchanged.
• Cash and cash equivalents increased $7.3 billion to $138.6 billion. Cash flows were $26.7 billion provided by operations, $4.2 billion used in investing and $12.2 billion used in financing.
• Capital ratios at year-end under Basel 3 transition rules were 12.3% common equity tier 1, 13.4% Tier 1, 16.5% total capital and 8.2% Tier 1 leverage. Global Excess Liquidity Sources were $439 billion, including $98 billion at the parent company; parent-company time-to-required funding was 39 months.

For the fourth quarter, net income was $3.05 billion and diluted EPS was $0.25, compared with $3.44 billion and $0.29 a year earlier. Revenue was $18.7 billion versus $21.5 billion.

Changes, outlook, risks and unusual items

• Major earnings drag: Litigation expense increased $10.3 billion in 2014, primarily related to settlements with the U.S. Department of Justice (DoJ) and Federal Housing Finance Agency (FHFA). The DoJ settlement included $9.65 billion in cash payments during 2014 and $7.0 billion of consumer relief to be delivered by August 31, 2018; an additional $400 million provision covered consumer-relief costs. The FHFA settlement involved a $9.5 billion payment and receipt of securities valued at approximately $3.2 billion.
• Other revenue declines included mortgage banking income, down $2.3 billion, and trading account profits, down $747 million. Investment and brokerage services income rose $1.0 billion, supported by higher asset-management fees. A new funding valuation adjustment generated a $497 million pretax charge.
• Management said Project New BAC achieved its $2 billion quarterly expense-savings target in the third quarter of 2014, ahead of schedule. It expected Legacy Assets & Servicing costs, excluding litigation, to reach approximately $800 million per quarter by the end of 2015.
• Management expected reserve releases in 2015 to moderate versus 2014 and an effective tax rate in the low-30% range absent unusual items. The company was asset-sensitive in its stated interest-rate scenarios: an instantaneous +100-basis-point parallel shift was estimated to increase next-12-month pretax net interest income by $3.7 billion. The estimate assumes no management response or deposit-mix change.
• Mortgage and litigation exposure: Unresolved repurchase claims were $22.4 billion net of duplicate claims, including $4.7 billion the company believed were time-barred. The recorded representations-and-warranties liability was $12.1 billion, with an estimated reasonably possible loss of up to $4 billion above that liability. These figures exclude certain servicing, fraud, indemnity and securities-litigation exposures. The BNY Mellon settlement remained subject to appeals and final court approval.
• The filing estimated an aggregate $0–$2.7 billion range of possible loss above accrued liabilities for certain litigation matters; this excludes matters for which a range could not be estimated and is not a maximum exposure. The O’Donnell matter resulted in a $1.3 billion civil penalty against BANA, which the company planned to appeal. Separately, the OCC imposed a $250 million FX-related penalty and remedial measures; discussions with another U.S. regulator remained ongoing.
• Regulatory changes may require additional capital, liquidity and compliance spending. Management noted that required modifications to internal Basel 3 advanced-approach models could materially increase risk-weighted assets and lower capital ratios. The proposed U.S. GSIB surcharge, leverage rules and other evolving requirements could constrain capital distributions.
• Other stated risks include prolonged low interest rates, credit-rating downgrades and collateral calls, housing and HELOC performance (many HELOC draw periods do not end until 2016 or later), energy-sector weakness following falling oil prices, cyber and operational incidents, and international market and geopolitical stress. A proposed accounting standard for expected credit losses could materially reduce retained earnings when adopted.

Most important facts for investors to verify

• Whether litigation and mortgage-related losses, settlements and consumer-relief costs remain within recorded accruals and disclosed possible-loss ranges, including the outcome of the BNY Mellon appeals.
• Whether core revenue and earnings recover as litigation charges recede, given falling net interest income, mortgage revenues and the reduced loan balance.
• How 2015 reserve releases compare with management’s expectation of moderation, and whether consumer credit trends remain favorable as HELOCs enter amortization.
• Fully phased-in capital ratios, final regulatory model approvals and the effects of the GSIB surcharge, supplementary leverage ratio and liquidity standards on capital returns.
• Whether the higher common dividend is sustainable and what capital distributions are permitted under Federal Reserve review; the filing said no additional common-stock repurchases were planned through the first quarter of 2015 absent approval.