BANK OF AMERICA CORP quarterly report, Q2 FY2013

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Bank of America Corporation — Q2 2013 Form 10-Q

Business context and period. The filing covers the quarter and six months ended June 30, 2013. Bank of America is a diversified U.S. and international financial services company operating through Consumer & Business Banking, Consumer Real Estate Services, Global Banking, Global Markets, Global Wealth & Investment Management, and All Other. It reported approximately $2.1 trillion of assets and 257,000 full-time equivalent employees at quarter-end.

Financial performance and position

  • Quarterly results: Net income was $4.0 billion, or $0.32 per diluted share, versus $2.5 billion, or $0.19, in Q2 2012. GAAP revenue was $22.7 billion, up from $22.0 billion; revenue on a fully taxable-equivalent (FTE) basis was $22.9 billion, versus $22.2 billion.
  • First-half results: Net income was $5.5 billion, or $0.42 per diluted share, compared with $3.1 billion, or $0.22, in the first half of 2012. GAAP revenue was $45.9 billion, versus $44.2 billion.
  • Interest income and margins: Q2 GAAP net interest income was $10.5 billion; FTE net interest income was $10.8 billion, up $989 million year over year. FTE net interest yield was 2.44%, up 23 basis points. The FTE efficiency ratio improved to 69.80% from 76.79%.
  • Expenses and credit: Q2 noninterest expense fell $1.0 billion to $16.0 billion, primarily reflecting lower litigation, professional fees and personnel costs. Provision for credit losses declined $562 million to $1.2 billion. Net charge-offs were $2.1 billion, or 0.94% of average loans, versus $3.6 billion, or 1.64%, a year earlier.
  • Balance sheet and capital: At June 30, assets were $2.123 trillion, loans and leases $921.6 billion, deposits $1.081 trillion, and shareholders’ equity $231.0 billion. Long-term debt was $262.5 billion, down from $275.6 billion at December 31, 2012. Basel 1–2013 capital ratios were 10.83% Tier 1 common, 12.16% Tier 1, 15.27% total capital and 7.49% Tier 1 leverage.
  • Credit quality: The allowance for loan and lease losses was $21.2 billion, or 2.33% of loans, down from $24.2 billion, or 2.69%, at year-end. Nonperforming loans, leases and foreclosed properties were $21.3 billion, compared with $25.4 billion at year-end.
  • Cash flow and liquidity: First-half operating cash flow was $72.6 billion, investing cash flow was negative $2.3 billion, and financing cash flow was negative $80.1 billion. Cash and cash equivalents declined $11.9 billion to $98.8 billion. Global Excess Liquidity Sources were $342 billion, including $95 billion at the parent company; parent-company Time to Required Funding was 32 months against a 21-month minimum target.

Material changes versus comparable periods

  • Profit rose substantially year over year, supported by higher net interest income, lower credit-loss provisions and lower quarterly expenses. First-half revenue also increased, while the efficiency ratio improved.
  • Credit indicators improved: first-half net charge-offs fell to $4.6 billion from $7.7 billion, and nonperforming loans and foreclosed properties declined from year-end. Management attributed much of the improvement to housing and portfolio trends.
  • Mortgage banking income weakened: Q2 consolidated mortgage banking income was $1.2 billion, down from $1.7 billion, mainly because of reduced servicing income and a smaller servicing portfolio. CRES recorded a $937 million quarterly net loss and a $3.1 billion first-half net loss.
  • Global Markets reported Q2 net income of $959 million, up from $497 million; first-half net income was $2.1 billion, versus $1.3 billion. Excluding net debit valuation adjustment effects, first-half Global Markets net income declined, principally reflecting weaker fixed-income, currencies and commodities revenue.
  • Higher interest rates reduced the fair value of available-for-sale securities: accumulated OCI included an after-tax net unrealized loss of $645 million on AFS debt securities at June 30, versus a net unrealized gain at year-end. Shareholders’ equity declined $5.9 billion from year-end.

Outlook, management commentary, risks and unusual items

  • Credit outlook: If economic improvement continues, management anticipates further allowance reductions, particularly in consumer real estate. It expected Q3 2013 net charge-offs below $2.0 billion.
  • Costs and mortgage servicing: Project New BAC targets annualized savings of $8 billion by mid-2015, with approximately $1.5 billion in quarterly savings expected by Q4 2013. Management expected Q4 Legacy Assets & Servicing noninterest expense, excluding litigation, below $2.0 billion and 60-days-or-more-past-due residential mortgages in the Legacy and Non-Legacy serviced portfolios below 375,000; the reported June 30 count was 492,000.
  • Rates and mortgage business: Management expected higher rates to reduce mortgage originations, particularly refinancing. The company was asset-sensitive to interest rates, but warned that rising rates could reduce AFS securities values and adversely affect OCI and capital.
  • Mortgage settlements and litigation: The May MBIA settlement resolved litigation and claims for $1.565 billion in cash plus approximately $95 million of MBIA notes; the Corporation also provided a $500 million secured credit facility to an MBIA affiliate. The FNMA settlement included a $3.6 billion cash payment and repurchase of certain loans for $6.6 billion. The representations-and-warranties liability was $14.0 billion, with estimated possible losses up to $4 billion above accruals; this estimate excludes possible monoline losses and certain other claims. Separately, the estimated aggregate range of possible loss for certain litigation and regulatory matters was $0–$2.8 billion above accrued liabilities, where estimable. Actual outcomes could be material.
  • Regulatory capital: Final Basel 3 rules were approved in July 2013 and were expected to take effect January 1, 2014, with transition periods. The Corporation estimated a fully phased-in Basel 3 Advanced Approach Tier 1 common ratio of 9.60%, subject to model approval and estimates. A proposed supplementary leverage ratio could constrain capital distributions if its proposed buffer is not maintained.
  • Subsequent tax item: A UK tax-rate reduction enacted July 17, 2013 is expected to produce an approximately $1.1 billion income-tax charge in Q3 2013 as deferred tax assets are remeasured; management said it would not affect capital ratios.
  • Other risks: Risks include unresolved private-label mortgage claims (which management expected to continue increasing), mortgage servicing and foreclosure matters, regulatory actions, European market stress, credit-rating downgrades and associated collateral demands, and implementation costs or business changes from derivatives regulation. A July 31, 2013 court ruling required reconsideration of the debit-card interchange-fee cap, potentially affecting future revenue.

Most important facts for an investor to verify

  • Reconcile GAAP revenue and net interest income with the company’s FTE non-GAAP measures and review the stated adjustments.
  • Assess whether lower credit costs and allowance releases are sustainable, including the effect of purchased credit-impaired loan write-offs.
  • Track mortgage servicing portfolio runoff, MSR transfers, mortgage production, foreclosure costs and progress toward management’s delinquency and expense targets.
  • Review the adequacy of mortgage representations-and-warranties reserves and possible losses, including claims and litigation excluded from the stated estimates.
  • Monitor the Q3 deferred-tax charge, Basel 3 implementation and model approvals, capital ratios, liquidity sources and any capital-distribution constraints.
  • Examine first-half operating cash flow in light of its large contribution from changes in trading instruments and other balance-sheet items, and distinguish it from recurring earnings-based cash generation.