BANK OF AMERICA CORP quarterly report, Q3 FY2010

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Bank of America Corporation — Q3 2010 Form 10-Q

Business context and period. Unaudited consolidated results cover the three and nine months ended September 30, 2010, compared with the same 2009 periods. Bank of America reported $2.34 trillion in assets and operated through six business segments. Year-over-year comparisons are affected by 2010 consolidation of certain securitization trusts and other VIEs; prior-year card results were presented on a managed basis.

Financial results and condition

  • Revenue: Third-quarter revenue, net of interest expense, was $26.7 billion under GAAP ($27.0 billion on a fully taxable-equivalent, or FTE, basis), up 2% from Q3 2009. Nine-month GAAP revenue was $87.8 billion ($88.7 billion FTE), down 7%.
  • Profit: Q3 net loss was $7.3 billion, or $0.77 per diluted share, versus a $1.0 billion loss a year earlier. Excluding the $10.4 billion goodwill impairment, management reported non-GAAP net income of $3.1 billion and diluted EPS of $0.27. Nine-month net loss was $994 million, or $0.21 per diluted share; excluding the impairment, net income was $9.4 billion and diluted EPS was $0.82.
  • Interest income and margins: Q3 net interest income was $12.4 billion GAAP ($12.7 billion FTE), up from $11.4 billion GAAP. FTE net interest yield was 2.72%, versus 2.61%. Nine-month GAAP net interest income rose to $39.1 billion from $35.6 billion; the FTE yield was 2.81%, versus 2.65%.
  • Credit costs: Provision for credit losses was $5.4 billion in Q3 and $23.3 billion for nine months, down from $11.7 billion and $38.5 billion, respectively. Net charge-offs were $7.2 billion in Q3 and $27.6 billion year to date; annualized ratios were 3.07% and 3.84%. The allowance for loan and lease losses was $43.6 billion, or 4.69% of loans, at September 30.
  • Expenses and efficiency: Q3 noninterest expense was $27.2 billion, including the $10.4 billion goodwill charge; nine-month expense was $62.2 billion. The Q3 FTE efficiency ratio was 100.87%, or 62.33% excluding goodwill impairment (non-GAAP).
  • Cash flow: For nine months, operating activities provided $77.4 billion, investing activities used $57.0 billion, and financing activities used $10.8 billion. Cash and cash equivalents increased $9.8 billion to $131.1 billion.
  • Balance sheet and funding: At quarter-end, loans and leases were $933.9 billion, deposits $977.3 billion, total assets $2.34 trillion, total liabilities $2.11 trillion, long-term debt $478.9 billion, and shareholders’ equity $230.5 billion. Total assets rose $109.4 billion from year-end 2009; deposits fell $14.3 billion.
  • Capital and liquidity: Regulatory Tier 1 common, Tier 1, total capital and Tier 1 leverage ratios were 8.45%, 11.16%, 15.65% and 7.21%. Global excess liquidity sources were $324 billion, up from $214 billion at year-end. Parent-company Time to Required Funding was 23 months, above the 21-month minimum target.

Material changes versus comparable periods

  • Q3’s reported loss chiefly reflects a $10.4 billion noncash, nondeductible goodwill impairment in Global Card Services. The charge followed estimated debit-interchange revenue pressure from the Financial Reform Act.
  • Credit-loss provisions declined substantially as delinquencies, bankruptcies and criticized commercial exposures improved; however, nine-month net charge-offs increased from $25.3 billion to $27.6 billion, and the allowance-to-loans ratio rose from 3.95% at December 31, 2009 to 4.69%.
  • Net interest income increased, aided by lower deposit costs and consolidation accounting, but core net interest income and loan balances remained pressured by lower consumer and commercial lending and weak demand. FTE net interest income included $2.6 billion in Q3 and $8.1 billion year to date from the new consolidation guidance.
  • Noninterest income fell year to date, reflecting lower equity investment income, trading profits, securities-sale gains, service charges and mortgage banking income. Q3 mortgage banking income improved, but representations-and-warranties expense increased.
  • Goodwill declined to $75.6 billion from $86.3 billion at year-end, principally because of the impairment and asset sales. Common shares outstanding increased to 10.03 billion from 8.65 billion at year-end, largely following conversion of Common Equivalent Stock.

Outlook, risks and unusual items

  • Management outlook: Management described the recovery as fragile, with high unemployment, stressed real estate markets, cautious businesses and weak loan demand. It said improving credit trends could continue, while low loan growth could weigh on net interest income. No broad earnings guidance was provided.
  • Regulation and revenue: Management estimated the CARD Act would reduce 2010 revenue by about $1 billion after tax. Regulation E and overdraft policy changes were also expected to reduce 2010 revenue by about $1 billion after tax; the Q3 pre-tax service-charge impact from Regulation E was about $375 million. Debit-interchange limits were expected to reduce revenue by about $2 billion annually at current volumes beginning in Q3 2011, before mitigation.
  • Foreclosures: After quarter-end, the company paused foreclosure proceedings to judgment in judicial states and foreclosure sales nationwide while reviewing processes. It began resubmitting affidavits in 23 states; the review could affect up to 102,000 pending cases. Management expected higher servicing and legal costs into 2011 and warned delays could increase nonperforming loans and servicing advances and affect MSR value. Federal and state investigations and potential litigation were also noted.
  • Mortgage representations and warranties: The recorded liability was $4.4 billion at September 30, up from $3.5 billion at year-end; expense was $872 million in Q3 and $2.6 billion for nine months. Outstanding repurchase claims were $12.9 billion. The filing says some potential monoline and private-label claims cannot be reasonably estimated; a separate aggregate range for certain litigation and regulatory matters was $400 million to $1.9 billion in excess of related accruals, not a maximum-loss estimate.
  • Other contingencies: A $592 million liability was recorded for U.K. payment-protection-insurance claims; further exposure could not yet be estimated. Litigation-related costs were $1.2 billion for nine months. The company cited an estimated $400 million to $1.9 billion aggregate range of possible loss above accruals for specified matters, while warning actual outcomes could differ materially.
  • Accounting and capital changes: Adoption of new VIE consolidation guidance added $100.4 billion of assets and $106.7 billion of liabilities and reduced opening retained earnings by $6.2 billion, net of tax. The company also disclosed proposed Basel capital and liquidity requirements and the planned phaseout of trust preferred securities from Tier 1 capital.

Most important facts for investors to verify

  • Reconcile reported Q3 and year-to-date losses with management’s non-GAAP results excluding the goodwill impairment, including the assumptions behind the Global Card Services valuation and projected debit-interchange impact.
  • Track allowance adequacy and credit trends, especially home-equity, residential mortgage, purchased credit-impaired loans, commercial real estate and card charge-offs; note that several consumer products are excluded from reported nonperforming-loan measures.
  • Assess the ultimate cost and duration of foreclosure reviews, servicing delays, investigations and private-label mortgage claims, including whether further repurchase reserves are required.
  • Monitor whether the $324 billion of reported excess liquidity is available at the entities that need it, and whether capital ratios remain adequate under new regulatory rules and trust-preferred phaseouts.
  • Distinguish ongoing earnings from one-time investment gains, securities transactions, valuation adjustments, consolidation effects and other non-GAAP or fair-value items.