Bank of America Corporation — Q2 2012 Form 10-Q
Business context and reporting period. The filing covers the quarter and six months ended June 30, 2012; it was signed August 2, 2012. Bank of America reported approximately $2.16 trillion in assets and operated through five segments: Consumer & Business Banking, Consumer Real Estate Services, Global Banking, Global Markets, and Global Wealth & Investment Management. Segment presentation changed in 2012, with prior periods reclassified.
Financial performance and condition
- Q2 earnings: Net income was $2.46 billion, or $0.19 diluted EPS, versus a net loss of $8.83 billion, or $0.90 per share, in Q2 2011. Six-month net income was $3.12 billion versus a $6.78 billion loss.
- Revenue: Q2 GAAP revenue, net of interest expense, was $21.97 billion; revenue on the fully taxable-equivalent (FTE) basis was $22.20 billion, up from $13.24 billion GAAP and $13.48 billion FTE in the prior-year quarter. Six-month GAAP revenue was $44.25 billion, up from $40.11 billion.
- Net interest income and margin: Q2 GAAP net interest income was $9.55 billion, down 15% year over year; FTE net interest income was $9.78 billion, down 15%. FTE net interest yield was 2.21%, versus 2.50% a year earlier. Lower consumer loan balances and yields and lower securities yields were partially offset by lower funding costs and reduced long-term debt.
- Credit costs and asset quality: Q2 provision for credit losses was $1.77 billion, down from $3.26 billion; six-month provision was $4.19 billion versus $7.07 billion. Q2 net charge-offs were $3.63 billion, or 1.64% annualized, versus $5.67 billion and 2.44%. Period-end nonperforming loans, leases and foreclosed properties were $25.38 billion, down from $30.06 billion at year-end 2011. The allowance for loan and lease losses was $30.29 billion, or 3.43% of loans, versus $33.78 billion and 3.68% at year-end.
- Expenses and efficiency: Q2 noninterest expense was $17.05 billion, down from $22.86 billion; six-month expense was $36.19 billion, down from $43.14 billion. The Q2 FTE efficiency ratio was 76.79%; the prior-year comparison was not meaningful under the filing’s presentation.
- Balance sheet, debt and liquidity: Total assets were $2.16 trillion, loans and leases $892.3 billion, deposits $1.04 trillion, and shareholders’ equity $236.0 billion. Long-term debt was $301.8 billion, down from $372.3 billion at December 31, 2011. Global excess liquidity sources were $378 billion; parent-company liquidity was $111 billion. Parent-company “Time to Required Funding” was 37 months against a 21-month minimum target.
- Capital: Tier 1 common, Tier 1, total capital and Tier 1 leverage ratios were 11.24%, 13.80%, 17.51% and 7.84%, respectively, compared with 9.86%, 12.40%, 16.75% and 7.53% at year-end 2011.
- Cash flow: For the first six months, operating cash flow was $2.75 billion, investing cash flow was negative $3.64 billion, financing cash flow was positive $4.77 billion, and cash and cash equivalents increased $3.62 billion to $123.72 billion. Operating cash flow was substantially below the prior-year $51.20 billion.
Material changes versus comparable periods
- The earnings turnaround chiefly reflects unusually large prior-year mortgage representations-and-warranties provisions, including the BNY Mellon settlement, and a $2.60 billion goodwill impairment in Q2 2011. The 2012 Q2 representations-and-warranties provision was $395 million versus $14.04 billion a year earlier; this comparison is not a like-for-like measure of underlying recurring performance.
- Lower credit costs, lower mortgage-related expenses and litigation expense also supported the year-over-year improvement. Q2 litigation expense was $963 million; six-month litigation expense was $1.8 billion.
- Net interest income remained under pressure. Durbin Amendment interchange rules reduced debit-card revenue; card income declined $389 million in Q2 year over year. Trading and investment banking revenue also weakened amid lower activity and market uncertainty.
- Results varied by segment: Q2 net income fell at Consumer & Business Banking ($1.16 billion versus $2.50 billion), Global Banking ($1.41 billion versus $1.92 billion) and Global Markets ($462 million versus $911 million). Consumer Real Estate Services’ loss narrowed to $768 million from $14.51 billion, while Global Wealth & Investment Management income rose to $543 million from $513 million.
Outlook, commentary, risks and unusual items
- Management expected net interest income to improve modestly in Q3 2012 if interest rates remained at Q2 levels. It expected debit-card revenue to be about $420 million lower in Q3 2012 than Q3 2011 due to interchange rules.
- Project New BAC cost-savings targets were more than $1 billion in 2012 and $5 billion annualized by Q4 2013 for Phase 1, with full impact expected in 2014; Phase 2 was expected to add $3 billion annualized by mid-2015. These are forward-looking targets, not achieved savings.
- The U.K. Finance Bill enacted July 17 reduced the corporate tax rate to 23%. The company expected an approximately $800 million Q3 2012 tax charge to remeasure U.K. deferred tax assets; a further reduction to 22% could prompt an approximately $400 million charge, assuming no change in deferred tax assets.
- Mortgage and legal exposures remain major uncertainties. The BNY Mellon Settlement still required final court approval. Unresolved repurchase claims rose to $22.7 billion from $12.6 billion at year-end; the company expected them to continue increasing. It estimated up to $5 billion of possible additional non-GSE representations-and-warranties losses over existing accruals, while additional GSE losses could be material but could not be reasonably estimated.
- The global mortgage settlement included approximately $2.4 billion in upfront payments, already paid, and borrower-assistance commitments. The company believed it was likely to meet commitments, but failure could require additional cash payments; servicing standards and foreclosure delays could increase costs. A July 17 Syncora settlement had an approximately $400 million total cost, fully accrued at June 30.
- Moody’s downgraded the Corporation and Bank of America, N.A. by one notch in June. Management reported no material Q2 effect, but further downgrades could increase collateral requirements, trigger contract terminations or impair funding access. A one-notch downgrade scenario indicated approximately $2.3 billion of additional collateral requirements.
- Basel III rules were expected to increase capital requirements. The company estimated a fully phased-in Basel III Tier 1 common ratio of 8.10%, subject to assumptions including regulatory approval of internal models. The filing also cites European sovereign-debt stress, litigation and regulatory proceedings, mortgage servicing obligations, and execution risk for planned cost reductions.
Important facts for investors to verify
- How much of the earnings improvement is recurring after adjusting for prior-year mortgage provisions, goodwill impairment, debt-repurchase gains, securities-sale gains, structured-liability fair-value changes and derivative valuation adjustments.
- Whether mortgage repurchase claims, mortgage-insurance rescissions and servicing-related litigation require provisions beyond recorded amounts; confirm the status of the BNY Mellon Settlement and the disclosed non-GSE loss range.
- Whether the $800 million U.K. deferred-tax remeasurement charge and other subsequent events were recorded as expected in Q3.
- Whether credit quality and reserve reductions remain appropriate, particularly in legacy residential mortgage, home equity, PCI and commercial real-estate portfolios.
- Whether liquidity and capital remain adequate under further rating downgrades and final Basel III requirements, including the impact of collateral calls and trust-preferred-security phase-out.
- Whether Project New BAC savings and mortgage-servicing cost assumptions are being achieved without impairing revenue, controls or customer service.