Source: Seeking Alpha
Bank of America Corporation (NYSE:BAC)
Q3 2014 Results Earnings Conference Call
October 15, 2014 08:30 AM ET
Lee McEntire – Investor Relations
Brian Moynihan – Chief Executive Officer
Bruce Thompson – Chief Financial Officer
Betsy Graseck – Morgan Stanley
Glenn Schorr – ISI
Jim Mitchell – Buckingham Research
Jon McDonald – Sanford Bernstein
Mike Mayo – CLSA
Matt O’Connor – Deutsche Bank
Guy Moszkowski – Autonomous Research
Brennan Hawken – UBS
Ken Usdin – Jefferies
Paul Miller – FBR Capital Markets
Matthew Burnell – Wells Fargo
Chris Kotowski – Oppenheimer
Steven Chubak – Nomura
Bank of America (BAC) Q3 2014 Results Earnings Call – Webcast Audio
Good day, everyone. And welcome to today’s program. At this time, all participants are in a listen-only mode. Later you’ll have the opportunity to ask questions during the question-and-answer session. (Operator Instructions). Please note this call is being recorded and I will be standing by should you need any assistance.
It is now my pleasure to turn the conference over to Mr. Lee McEntire. Please go ahead, sir.
Lee McEntire – Investor Relations
Good morning. Thanks everybody on the phone as well as the webcast for joining us this morning for our third quarter results. Hopefully you’ve had a chance to review the earnings release documents available on our website.
Before I turn the call over to Brian and Bruce, let me just remind you, we may make some forward-looking statements today. For further information on those, please refer to either our earnings release documents, our website or our other SEC filings.
So with that, let me turn it over to Brian Moynihan, our CEO for some opening comments before Bruce goes through the details.
Brian Moynihan – Chief Executive Officer
Thanks, Lee, and good morning everyone. Thank you for joining us to review our third quarter results. As you know, our bottom-line results were heavily impacted by previously announced settlement with Department of Justice. But given that, I’m still encouraged by what we accomplished this quarter. Our business has generated enough earnings to absorb the $5.3 billion charge and still reported positive net income before preferred dividends.
Now, the themes that we see are consistent with the past several quarters. You can see in our numbers a prudent balance sheet management; you can see in the numbers good core expense control; you can see in the numbers continued credit improvement and you can see in the numbers solid business activity.
Before Bruce takes you through the detail of the quarter, I thought I’d focus quickly on the profitability of our business segments and some of the key statistics that give rise thereto. If you look, we’ve included in the appendix the materials on pages 18 and 20 some information about net income, PPNR and business statistics.
So you step back and look, you can see from our release, the company reported $2.9 billion in year-to-date pretax net income that includes and overcomes 15.6 billion in pretax litigation costs to resolve primarily legacy mortgage issues.
Now we’re not suggesting that we want to incur litigation cost going forward but what this demonstrates is how much progress we’ve made behind the noise of significant legal settlements. So you step back and think about the businesses, you can see on appendix slide 18 a graphic showing year-to-date net income comparative performance by the businesses.
Let’s first focus on our Consumer and Business Banking segment. Year-to-date net income was $5.3 billion in 2014. That compares to $4.6 billion after tax in 2013. The return on average allocated capital in Consumer & Business Banking was 24%. It is our largest business and it’s had a good year. Our Global Wealth and Investment Management business had net income of year-to-date of $2.3 billion in 2014 that’s up 3% from 2013. Now this business, our GWIM business has a pretax margin of 26% and has returns on allocated capital of 25%.
As we move to our Global Banking business, that’s the business provides lending, treasury services, investment banking activities to middle markets and large corporate clients around the world. That business earned $4 billion after tax so far this year, up 8% from 2013 and generated returns on allocated capital of 17%. Those three businesses together have great annuity streams and hold us in good state as we look forward.
Our Global Markets business which obviously is more affected by what’s going on in the market on the given quarter has earned $2.9 billion after tax this year and for the first nine months versus $2.7 billion in 2013 when you adjust for DVA and in 2013 you exclude the UK tax changes.
So in total, these four businesses generated $14.5 billion net income after-tax for the first nine months of 2014. That $14.5 billion is up 10% from last year. You can look on slide 19 and you can see on a pretax pre-provision basis which some of you also focus on, we are 4% year-over-year. And you can see on pages 20 and 21 the business statistics over the last couple of years which give rise to these results.
We’ve made real progress in the four businesses and we continue to work on the Consumer Real Estate segment and losses therein. But that real progress shows in the operating leverage profitability of these businesses and we expect that momentum to continue as we move the other side of the mortgage issues.
With that, I’ll turn it over to Bruce.
Bruce Thompson – Chief Financial Officer
Thanks Brian and good morning everyone. This quarter does reflect what we believe is very solid execution and a lot of what we’ve been consistently talking with all of you about. We maintained a strong balance sheet as a foundation to operate from. We continued to rationalize our balance sheet for liquidity, profitability as well as evolving regulatory changes. Our revenue has shown relative stability and our non-litigation expenses continue to be reduced. Charge-offs have continued to come down, and we resolved significant legacy mortgage exposures during the quarter.
Let’s start on slide two and go through the details. We recorded a $168 million of earnings in the third quarter and after preferred dividends that resulted in a loss of a penny per share. Earnings included the $5.3 billion pretax income — or pretax impact, excuse me of the settlement with the Department of Justice in various state attorneys general that we announced in August. On an EPS basis, the impact was $0.43 a share, as a portion this charge was not tax deductable.
As you can see on the right hand side of slide two, the $5.3 billion impact was split between $4.9 billion in litigation expense and $400 million in provision expense that relate to additional reserves that are associated with a consumer relief portion of this settlement.
Revenue during the quarter on an FTE basis was $21.4 billion versus $21.7 billion in the year ago quarter. If we exclude the DVA impact from both periods as well as the $1.2 billion of equity investment income that we recorded during the third quarter of ‘13 that was driven by gains from our CCB investment, adjusted revenue of $21.2 billion was up slightly from the third quarter of 2013.
On a segment view, revenue was stable to modestly up in four of our five businesses from last year with CRES being the exception. Relative to the second quarter of 2014, revenue was 3% lower driven by the lack of equity investment gains, seasonally lower investment banking fees and lower mortgage banking revenue.
Total non-interest expense was $19.7 billion which included $5.6 billion in total litigation expense. We back out litigation expense; compared to the second quarter of 2014, expenses declined roughly $400 million from both our New BAC and our ALS cost initiatives as well as lower revenue related incentives. On the same basis, looking back to the third quarter of 2013, expenses improved by $1.1 billion or 7% which were driven by reduced LAS costs and to a lesser degree our New BAC cost savings.
Provision for credit losses during the quarter was $636 million and included $400 million, as I mentioned for the DoJ Settlement, while our net charge-offs were $1 billion. Our results during the quarter did benefit from roughly $200 million in DVA or about a penny per share as our debt spread widened during the end of the quarter. There was also approximately $0.04 of benefit to earnings that relate to certain discrete tax items. Lastly, the quarter also benefited by about a penny as our weighted average share count excluded the impact of diluted shares given the financial performance.
On slide three, we show you all the usual balance sheet highlights that we do each quarter but we did want to focus you specifically on our efforts to rationalize the balance sheet as our actions led to a $47 billion decrease from the second quarter of 2014. We took prudent actions to increase liquidity as well as to reduce both credit and market risk. We shifted the mix of some of our discretionary assets out of less liquid loans into more liquid debt securities. For example, we converted 6.5 billion of residential mortgage loans that benefited from standby insurance agreements into agency securities. We also sold $2.5 billion of non-performing and delinquent loans during the quarter and had $4 billion of net pay downs in our legacy consumer real estate loans. We reduced our global markets balance sheet and associated funding by $11.7 billion from the second quarter of ‘14 and that included low margin prime brokerage loans of approximately $3.3 billion.
Our decline in quarter end deposits was primarily driven by optimization efforts that included the reduction of approximately 15 billion of deposits that had little to no benefit to our LCR ratio. From a capital perspective, I’ll remind you that we did issue 3.1 billion of preferred stock during the quarter that improved our Basel III Tier 1 regulatory capital ratio. And lastly as a reminder, we increased our quarterly common dividend to $0.05 a share during the quarter.
We move to slide four where we show our capital ratios under Basel III. Under the transition rules, our CET1 ratio was stable at 12%. If we look at our Basel III regulatory capital ratios on a fully phased-in basis, you can see CET1 capital declined 1.6 billion that was driven by a $1 billion decline in OCI.
Our operational risk weighted assets did increase that negatively impacted our advanced levels but not the standard levels. Other RWA balance sheet improvements benefited both approaches and that partially offset the increase in RWA under the advanced approach. If we look at the ratios under the standardized approach, CET1 improved slightly to 9.6% during the third quarter of ‘14 and under the advanced approach, the CET1 ratio was also at 9.6%, both well above our 8.5% 2019 proposed minimum requirements. If you look at our operational risk, risk weighted assets under the advanced approach; they now represent approximately 30% of our overall risk weighted assets.
We move to supplementary leverage. This is the first quarter that we’ve actually disclosed the actual ratios from a supplementary leverage perspective. The bank holding company during the third quarter was at 5.5%. And if we look at our primary banking subsidiary BANA, its ratio was 6.8% which is pro forma for September 30th as we merged FIA, our card services unit into BANA on October 1st. We’re obviously very pleased with the capital and supplementary leverage ratios in the context of the resolution of the DoJ matter during the quarter.
We turn to slide five, feel very good about the work that the funding team did during the quarter. In addition to the $3.1 million of preferred stock issuance, we issued 3 billion of Tier 2 subordinated debt, which also adds to our total capital metrics.
Lastly, we issued $4.5 billion of straight debt at the parent. Our goal is not only to build the Basel III non-CET1 component of the capital stack that we thought or levels that were appropriate, but also to build liquidity in advance of the payments that we’ll make during the month of October for the DoJ and state AG settlement.
Total long-term debt for the quarter ended at $250 billion, which was down $7 billion from the end of the second quarter 2014. We look at the cost of our debt; our long-term debt yields improved 10 basis points from the second quarter of ‘14 due primarily to maturities of higher yielding debt as well as issuances at more favorable levels. Global access liquidity sources remained very strong at 429 billion and our time to required funding was stable at 38 months.
We turn to slide six; net interest income on a reported FTE basis was 10.4 billion, up from the second quarter of ‘14 as we had a less negative impact from market related adjustments and that was coupled with modest improvement in our adjusted net interest income.
The market related adjustments during the quarter were a negative $55 million in the third quarter of ‘14 that compares to a negative $175 million in the second quarter of ‘14.
Net interest income of $10.5 billion excluding the market related adjustment, improved modestly as lower long-term debt balances and yield as well as an extra day of interest accruals were partially offset by lower loan balances as well as lower loan yields.
The net interest yield improved 4 basis points on an adjusted basis and 7 basis points on an actual basis. We continue to remain positioned to benefit as interest rates move higher, particularly from the short end of the curve.
Since we’re largely done at this point with our debt footprint reductions, the direction as well as the trajectory of our net interest income and net interest yield will be more dependent on rates as well as balance sheet movements going forward.
And given the volatility of the rates, should the opportunity present itself, we could decide to take actions to reduce OCI risk in preparation for what we will be in an eventual rising rate environment. Those actions could have a relatively small near term impact to net interest income but reduced our duration risk as well as to provide additional liquidity to reinvest in a higher rate environment.
Non-interest expense on slide seven was $19.7 billion in the third quarter of ‘14 and included $5.6 billion of litigation expense. As I previously mentioned, $4.9 million of the expense related to the DoJ Settlement while the remainder was associated with the number of smaller pre-existing cases, one of which caused us to book approximately $200 million in our Global Markets business.
We exclude litigation; total expenses were $14.2 billion this quarter which declined $400 million from the second quarter of 2014 on both, our New BAC as well as our LAS initiatives as well as lower revenue related incentive cost. Compared to the third quarter of ‘13, expenses are $1.1 billion lower, driven by LAS cost savings. Our legacy assets and servicing cost once again ex-litigation reduced by approximately a $100 million in the quarter and remained on track to hit $1.1 billion in the first quarter of 2015.
In the third quarter, we’ve now reached our new BAC savings initiatives with the targeted goal of $2 billion a quarter or $8 billion on an annualized basis. So, as we move forward, we believe that expenses apart from litigation as well as the continued reductions in legacy assets and servicing expenses should move more directionally with the revenue streams that we see in the businesses.
Asset quality on slide eight, you can see credit quality continued to improve. Net charge-offs declined slightly from the second quarter of ‘14 to $1 million or a 46 basis-point net loss ratio, a new decade low. NPL sales which I mentioned produced modest recovery in both the second quarter of ‘14 as well as the third quarter of ‘14. And if we normalize for those benefits, net charge-offs would have been $1.3 billion in the second quarter of ’14 and $1.2 billion in the third quarter of ’14 with the third quarter being about 8% lower.
Delinquencies, a leading indicator of net charge-offs remained very low. Our third quarter provision expense was 636 million and we released 407 million of reserves, given the continued pace of asset quality improvement. If we exclude the reserve that was associated with the DOJ Settlement, we released 807 million from our reserves.
Let’s now focus on the businesses, starting on slide nine with Consumer & Business Banking. Results again this quarter showed year-over-year improvement as our net income grew 4% to 1.9 billion and increased 3% from the second quarter of 2014. This business generated 25% return on allocated capital during the third quarter. Revenue was relatively stable at 7.5 billion compared to the third quarter of ’13 and up from the second quarter of ’14, led by higher card income and service charges for both comparative periods.
As you can see on the slide, Q3 provision expense was lower than the third quarter of ‘13 as net charge-offs improved and we also released less reserves. Expenses of 4 billion were stable compared to both periods as the benefits from our net book delivery optimization were offset by investments that we made in our special sales force.
With regard to the special sales force, over the course of the last year, we’ve added nearly 500 financial solutions advisors and small business bankers. Growth in mobile as well as other self-service customer touch points has allowed us to continue to reduce our banking centers where we went below 5,000 units during the quarter, while at the same time, our customer satisfaction scores continued to improve and customer activity continues to build.
We look at customer activity during the quarter. We had good deposit growth and our rates paid remained very low. We experienced modest improvement in average loans on a linked quarter basis driven by activities that we saw within the U.S. consumer credit card business. Brokerage assets were up 21% year-over-year as we benefited from both improved account flows and market valuation.
Our mobile banking customers reached over 16 million during the quarter and 11% of all of our customer deposit transactions are now done through mobile devices. Card issuance remained strong at 1.2 million new accounts in the third quarter of ‘14 with 64% of those cards going to existing customers of our company. And lastly, credit quality continued to improve as our U.S. credit card loss rate fell below 3% and where we continue to see north of a 9% risk adjusted margin.
If we moved to consumer real estate services; as I mentioned, the loss in the quarter was driven by the DOJ settlement, which impacted expense, provision, as well as income tax. Revenue was down about $300 million from the second quarter of 2014. The servicing income component of revenue was driven by an approximate $100 million charge to adjust our MSR for cost of service assumptions. And a smaller amount in our level of servicing assets did decline.
Our production revenue decline was driven by approximate $80 million increase in rep and warrant expense. First mortgage retail origination of $11.7 billion, were up 6% from the second quarter of 2014. If we look at the pipeline at the end of the quarter, our first-lien origination pipeline was down 12% from the second quarter of 2014.
On the home equity front, we continue to see very good demand where originations during the quarter were $3.2 million, which were up nicely on both the linked quarter and a year-over-year basis.
Expenses once again included $5.3 billion of litigation costs during the quarter versus $3.8 billion in the second quarter of 2014. If we exclude that $1.5 billion increase in litigation cost, expenses declined a $117 million.
Our LAS expense for the quarter was just over $1.3 billion and once again remains on track to hit $1.1 billion in the first quarter of 2015. Our number of 60 plus day delinquent loans of $221,000 that are serviced by LAS dropped $42,000 or 16% from the end of the second quarter of ‘14. In addition, we continue to reduce our production staffing levels in line with the market opportunity as we continue to lower our fulfillment cost.
On slide 11, global wealth and investment management delivered another strong quarter, where we saw both record revenues, as well as record earnings. Pre-tax margins remained strong, north of 25% for the 7th consecutive quarter.
Record asset management fees drove revenue higher, but were offset by some softness in transactional activity, although I do want to mention that we did see transactional activity pickup during the month of September.
Net income of $830 million was up 12% on a linked quarter basis as the business continues to focus on operating leverage and drop the revenue growth to the bottom-line. We increased the number of financial advisors and year-to-date the retention of our more experienced advisors remains at record levels.
Client balances were nearly $2.5 trillion with negative market valuation mostly offset by positive flows that we saw during the quarter. Long-term AUM flows were $11.2 billion during the quarter, the 21st consecutive quarter of positive flows. Ending client loan balances also increased to a record level from the second quarter of ‘14 as we see good activity in both securities-based and residential mortgage lending. And return on allocated capital in this segment was 27% during the quarter.
If you turn to slide 12, global banking earnings were $1.4 billion, which is up 24% from the third quarter of ‘13 on both on lower credit cost and to a lesser degree higher revenue. Compared to the second quarter of ‘14, earnings were up on lower credit costs, which were slightly offset by seasonally lower investment banking fees.
Return on allocated capital during the quarter was strong at 18%. Within the revenue line item, investment banking fees for the company this quarter were $1.4 billion, which is up 4% from the year ago quarter, but down seasonally from the second quarter of 2014. Our overall investment banking pipeline does remained very strong, but I do want to note that our fourth quarter of ‘13 was a record quarter from an investment banking fee perspective. Provision during the quarter was a slight benefit, which reflected continued low loss rates and a small reserve release.
If we look at the balance sheet, average loans were $267 billion, which is up 3% compared to the year ago period, but which has slowed over the past couple of quarters as we continue to focus on client profitability. We’ve also seen some significant prepayments from some of our larger corporate banking clients during the last couple of quarters.
Although our average deposits during the quarter did increase, our end of period balances declined. And that’s due as I mentioned earlier, that we intentionally managed down certain deposits which have a little LCR benefit.
If we move to Global Markets on slide 13, we earned $769 million during the third quarter of 2014. To put the third quarter of ‘14 on a like basis to the third quarter of ‘13, you should exclude a $1.1 billion impact from the UK tax rate change that we saw in the third quarter of ‘13, as well as the impact of DVA for both periods. Once again DVA this quarter was a benefit of $205 million versus a decrement of $444 million last year. If we make those adjustments, we saw very strong growth in earnings of 21% on a year-over-year basis.
Earnings are down from the second quarter of ‘14 as a result of the typical seasonal declines in sales and trading, as well as higher litigation expense during the third quarter of ‘14 within this segment.
If we back out DVA, revenue is up 7% from the year ago period driven by strong sales and trading results. We’re pleased to report both FICC and equity sales and trading revenues were up versus the year ago period. FICC revenues were up 11%. The improvement was driven by results and currencies given the increased volatility that we saw during the month of September, as well as improved performance in both our mortgages and our commodities areas.
Equity sales and trading was up as well, up 6% from the third quarter of ‘13 driven by a higher client financing revenues. On the expense front, they were up 2% year-over-year driven by higher revenue-related incentives. Relative to the second quarter, expenses were up $70 million from the second quarter due to higher litigation expense. If we back out the $200 million litigation expense during the quarter, expenses declined by about $130 million in line with the lower revenue levels on a linked quarter basis.
Average trading-related assets were down about $13 billion from the second quarter of ‘14 and our overall bar remains very low. Return on allocated capital during the quarter was 9%.
On slide 14, we show all other. Our non-interest revenue during the quarter was down on a year-over-year basis as we had $1.1 billion of equity investment gains in the third quarter of ‘13 and during the third quarter of ‘14, we had a $300 million charge for UK payment protection insurance.
Expenses on a year-over-year basis are down about $400 million due to lower litigation expense and all other, as well as lower personnel costs. Income tax expense is included within all other is the benefit related to discrete items that I mentioned earlier are largely reflected in this segment.
As we look at the fourth quarter of this year, we’d expect the tax rate to be roughly 31%, absent any unusual items during the quarter.
So before we open it up for questions, I’d like to summarize the quarter. We feel we made once again very good progress during the quarter. We saw good business activity across the customer footprint. This led to year-over-year earnings improvements in four out of the five businesses. And then in our mortgage business, we’re taking cost out of the legacy assets and servicing side and have taken cost out of the fulfillment side as well.
We generated enough earnings during the quarter from the businesses to offset a significant charge to settle our RMBS issues with the DOJ and RMBS working group. And at the same time maintain a very strong capital position. Asset quality continued its trend of improvement. And we did take some delivered balance sheet actions to improve liquidity, manage OCI risk and reduce both credit and market risk.
And we’ll go ahead now and open it up for questions.