DBRS Places Bank of America’s Long-Term Ratings Under Review – Negative, Confirms Short-Term Ratings

DBRS has today placed the long-term ratings of Bank of America Corp. (Bank of America or the Company), including its Issuer & Senior Debt rating of A (high) and the Deposit & Senior Debt rating of Bank of America, N.A. of AA (low), Under Review with Negative Implications. Concurrently, all FDIC-guaranteed debts and short-term ratings have been confirmed with a Stable trend. The trend on all long-term ratings, with the exception of the FDIC-guaranteed debts, had been Negative following the Company’s acquisition of Merrill Lynch & Co. (Merrill).

Today’s action follows Bank of America’s recently reported fourth-quarter loss as well as the $15.5 billion preliminary fourth quarter loss reported by Merrill. While DBRS had expected Merrill to struggle as it dealt with legacy exposures and still-disrupted capital markets, the fourth-quarter loss was beyond those expectations. Furthermore, in DBRS’s view, recent management changes at the newly combined company add to the challenges the Company faces as it undertakes what was already expected to be a challenging integration.

All this comes as the Company continues to deal with further weakening across most loan categories, especially consumer-related portfolios, and is experiencing ongoing asset quality deterioration related to acquisitions earlier in 2008 of Countrywide Financial Corporation and Lasalle Bank Corp. With respect to Countrywide, DBRS notes that in the fourth quarter, despite conservative marks taken at the time of acquisition on July 1, 2008, Bank of America took $750 million of charges against the acquired Countrywide portfolio, precipitated by the subsequent deterioration in housing markets.

The prospects of a more-difficult integration of Merrill and the significant headwinds Bank of America faces in its core Global Consumer and Small Business Banking (GCSB) segment in 2009 are additional drivers of the rating action in the current difficult operating environment and recessionary economy with steeply rising unemployment.

The review will focus on Bank of America’s core earnings generation capacity and the Company’s ability to absorb potential write-downs and the deteriorating trends in credit over the next four to eight quarters, at the same time that it is integrating the newly-acquired Merrill, continuing its integration of Countrywide and coping with the struggling U.S. economy. Given recent management changes, the review will also consider the emergence of a more cohesive management team.

The potential outcomes of the DBRS review are a downgrade of the long-term debt ratings of not more than one notch or a confirmation of the existing ratings with a return to Negative trend. The Stable trend for the Company’s R-1 (middle) Short-Term ratings reflects DBRS’s view that Bank of America’s short-term rating would likely remain at R-1 (middle), even if its long-term rating was downgraded. This view reflects the explicit government support that is already being provided, as well as the potential support implied by the SA2 designation assigned to the Company at the time of the acquisition. The support includes extensive liquidity that has been provided by various Federal Reserve facilities, as well as the Temporary Liquidity Guarantee Program of the Federal Deposit Insurance Corporation (FDIC).

Bank of America’s $2.4 billion loss (after preferred dividends) in Q4 2008 reflected challenging capital markets conditions and further deterioration in the credit quality across most of the Company’s loan portfolios. The Global Corporate and Investment Banking (GCIB) segment generated a $2.4 billion loss in the quarter driven by $4.6 billion of pre-tax market-disruption charges, primarily relating to Super-Senior CDO holdings, CMBS and leveraged loans. Even with elevated credit costs, however, the Global Consumer and Small Business Banking (GCSB) segment earned $835 million in the quarter. Bank of America’s other operating segment, Global Wealth and Investment Management (GWIM) also remained profitable despite difficult market conditions, earning $511 million in Q4 2008, up from $78 million in the third quarter. Reflecting primarily the poor performance of the GCIB, income before provisions and taxes was only $4.7 billion in Q4 2008, a significant decline from $8.0 billion in the prior quarter.

Credit quality deterioration was broad-based in the quarter. DBRS expects this broad deterioration in credit trends to continue as the impact of a recessionary economy is being exacerbated by declining housing prices and a sharp upturn in unemployment. Company-wide net charge-offs (NCOs) were $5.5 billion for the fourth quarter (2.36% of average loans), a 27% increase from Q3 2008. Non-performers were also up sharply, rising $4.7 billion to $18.2 billion at year-end from Q3 2008. With deteriorating trends, the Company added to its reserves with a quarterly provision that was $3 billion in excess of NCOs. In terms of coverage, Bank of America’s $23.1 billion allowance for loan losses (excluding the reserve for unfunded lending commitments) was 1.41x non-performing loans and 2.49% of total loans and leases.

Underpinning the ratings of Bank of America is its leading deposit franchise, and the Company continues to be a beneficiary of the flight to quality with substantial liquidity-enhancing deposit inflows. Even with the anticipated runoff that resulted from instituting pricing on some legacy Countrywide deposit accounts that reflected the Company’s overall funding needs, Bank of America grew deposits 1% (to $883 billion) from the end of the third quarter, while the average cost of interest-bearing deposits declined 40 bps from the prior quarter to 1.91%. As a result, net interest margin (NIM) also expanded in the quarter, up 38 bps to 3.31% as the benefit of lower deposit costs and lower short-term funding costs overwhelmed a 12 bps decline in the yield on earning assets. Net interest income of $13.1 billion increased 12.6% (un-annualized) from the third quarter.

The Merrill loss in the quarter prompted the U.S. Treasury in conjunction with the FDIC to provide additional support to Bank of America in the form of a $20 billion preferred stock investment and a loss-sharing, asset ring-fencing agreement for $118 billion of troubled assets under the Targeted Investment Program on January 16, 2009. This further investment was in addition to the Treasury’s $15 billion investment on October 28, 2008 and the January 9, 2009 post-Merrill closing $10 billion investment, both under the TARP Capital Purchase Program.

Bank of America’s estimated year-end Tier 1 ratio was 9.1%, while its tangible common equity ratio was 2.8%. Following the acquisition of Merrill Lynch and factoring in the capital relief associated with the government loss-sharing agreement, the estimated Tier 1 ratio would be 10.7%, while the tangible common ratio would slip to a below-average 2.6%. Liquidity remains strong, both at the holding company and the bank level and will benefit further from the additional investment by the government under its Targeted Investment Program.

Notes:
All figures are in U.S. dollars unless otherwise noted.

The applicable methodologies are Rating Banks and Bank Holding Companies Operating in the United States and Rating Securities Firms Operating in the United States, which can be found on our website under Methodologies.

This is a Corporate (Financial Institutions) rating.