Bank of America Corporation — Q2 2015 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2015. Bank of America is a diversified bank holding company with approximately $2.1 trillion in assets, operating through Consumer Banking, Global Wealth & Investment Management, Global Banking, Global Markets, Legacy Assets & Servicing (LAS), and All Other. Financial statements are unaudited.
Financial performance and condition
| Metric | Q2 2015 | Q2 2014 | Six months 2015 | Six months 2014 |
|---|---|---|---|---|
| GAAP revenue, net of interest expense | $22.1B | $21.7B | $43.3B | $44.3B |
| Net interest income (GAAP) | $10.5B | $10.0B | $19.9B | $20.1B |
| Net income | $5.32B | $2.29B | $8.68B | $2.02B |
| Diluted EPS | $0.45 | $0.19 | $0.72 | $0.14 |
| Provision for credit losses | $780M | $411M | $1.55B | $1.42B |
| Noninterest expense | $13.82B | $18.54B | $29.51B | $40.78B |
On a fully taxable-equivalent (FTE, non-GAAP) basis, Q2 revenue was $22.35 billion, up from $21.96 billion; net interest income was $10.72 billion, up from $10.23 billion. The FTE efficiency ratio improved to 61.84% from 84.43%, and return on average assets rose to 0.99% from 0.42%. The six-month FTE efficiency ratio was 67.43%, compared with 91.17%.
Higher earnings mainly reflect substantially lower litigation expense—management cited a $3.8 billion decrease for Q2 and a $9.5 billion decrease for the first half—plus lower expenses in other categories. The comparison is therefore strongly affected by prior-year legacy litigation costs. Lower noninterest income and higher credit-loss provisions partly offset the improvement.
- Balance sheet: Total assets were $2.149 trillion at June 30, up $44.5 billion from year-end 2014. Loans and leases were $886.4 billion; deposits were $1.150 trillion; shareholders’ equity was $251.7 billion. Long-term debt was $243.4 billion, broadly unchanged from year-end, while short-term borrowings increased 28% to $39.9 billion.
- Cash flow: For the first half, operating activities used $12.6 billion, versus $27.5 billion provided in the prior-year period. Investing activities used $18.4 billion; financing activities provided $56.3 billion. Cash and cash equivalents increased $24.9 billion to $163.5 billion. The filing attributes the operating cash-flow movement to changes in operating assets and liabilities, among other items.
- Capital and liquidity: Basel III Standardized—Transition CET1 capital was $158.3 billion, or 11.2%, versus 12.3% at December 31, 2014; the dollar amount increased, while the ratio fell as risk-weighted assets rose. The supplementary leverage ratio was 6.3%, above the stated 5.0% minimum threshold. Global Excess Liquidity Sources were $484 billion, with parent-company time-to-required funding of 40 months.
- Credit quality: Allowance for loan and lease losses was $13.1 billion, or 1.49% of loans, down from 1.75% at year-end. Nonperforming loans, leases and foreclosed properties were $11.6 billion, down from $15.3 billion at year-end. First-half net charge-offs were $2.26 billion, or 0.53% of average loans, compared with $2.46 billion and 0.55% in 2014.
Material changes and business trends
- LAS reported Q2 net income of $45 million versus a $2.74 billion loss a year earlier; first-half loss narrowed to $194 million from $7.62 billion. The improvement primarily reflected lower legacy litigation expense and higher mortgage banking income.
- Global Banking Q2 net income fell 13% to $1.25 billion, with lower revenue and a higher credit provision. Global Markets net income fell 10% to $993 million; trading revenue was weaker in credit-related businesses, partly offset by equities and rates, currencies and commodities activity.
- Consumer Banking Q2 net income increased 4% to $1.70 billion. Global Wealth & Investment Management net income declined 5% to $690 million, while client balances reached $2.52 trillion and assets under management were $930 billion.
- Commercial loans grew: period-end Global Banking loans were up 7% year over year, and total commercial loans and leases increased to $419.2 billion from $392.8 billion at year-end. Consumer loan balances continued to decline in some portfolios due to sales and runoff.
Outlook, risks and unusual items
- Management expected an effective tax rate of approximately 30% for the rest of 2015, absent unusual items. Proposed U.K. tax changes could produce an estimated $200–$300 million charge upon enactment and increase future tax expense.
- Management expected net charge-offs and credit-loss provision to align more closely during the remainder of 2015. LAS noninterest expense excluding litigation was expected to decline to approximately $800 million per quarter in Q4 2015.
- The June 2015 ACE decision on New York statute-of-limitations rules reduced unresolved mortgage repurchase claims and the related liability. At June 30, unresolved claims were $18.5 billion net of duplicates; the recorded representations-and-warranties liability was $11.6 billion, including $8.6 billion related to the BNY Mellon settlement. The estimated reasonably possible loss was up to $2 billion above accruals, not a probable loss. The settlement remained subject to tax-related conditions.
- Litigation and regulatory matters remain material uncertainties. For a limited group of matters, the estimated aggregate possible loss was $0–$2.3 billion above related accruals; this is not a maximum exposure. The filing says certain servicing-related claims cannot be reasonably estimated and excess exposure could be material in a reporting period.
- On May 20, the Corporation agreed to $205 million in civil penalties and remedial measures under a Federal Reserve consent order concerning its foreign-exchange business and controls. The OCC terminated BANA’s 2011 residential mortgage servicing consent order on June 17.
- Capital distributions remain subject to Federal Reserve review. The 2015 CCAR plan received a conditional non-objection; the Corporation was required to resubmit its plan by September 30, 2015 and address identified process weaknesses. It repurchased $775 million of common stock in Q2 and maintained a $0.05 quarterly dividend.
- Subsequent to quarter-end, the Federal Reserve finalized a G-SIB surcharge rule; the Corporation estimated a 3.0 percentage-point increase in risk-based capital requirements under stated assumptions, phased in from 2016 through 2019. Regulators’ requested changes to internal capital models could also reduce estimated fully phased-in Advanced Approaches CET1 from approximately 10.4% to 9.3%.
- Key ongoing risks include mortgage-related litigation and repurchase claims, regulatory and compliance costs, interest-rate and market moves, oil-and-gas borrower deterioration, international and sovereign exposures, credit-rating downgrades, and operational or cyber incidents. Management reported $2.9 billion net exposure to Russia and $276 million to Greece, and did not anticipate material Greek contagion at that time.
Most important facts for investors to verify
- How much of the earnings increase is sustainable after separating prior-year litigation expense, the ACE-related benefit, and other unusual items?
- Whether the BNY Mellon settlement conditions are satisfied and whether post-ACE claims, litigation or servicing matters change mortgage-related accruals or cash needs.
- Progress on the September 2015 CCAR resubmission, subsequent capital distributions, and the effect of G-SIB and internal-model requirements on capital ratios.
- Whether operating cash flow, net interest income and credit-loss trends improve, particularly as commercial lending grows and energy-sector credit risk remains.
- Liquidity availability by legal entity, given that some subsidiary liquidity is restricted from transfer to the parent without regulatory approval.