DBRS Comments on Bank of America’s 1Q11 Earnings; Senior Debt at “A” Unchanged

DBRS Inc. (DBRS) has commented today that its ratings for Bank of America Corp. (Bank of America or the Company) including its “A” Issuer & Senior Debt rating are unchanged following the announcement of the Company’s 1Q11 results. The trend on all ratings is Stable. Bank of America reported net income of $2.0 billion for the fourth quarter up from a $1.2 billion loss in 4Q10, but down 36% from the $3.2 billion earned in 1Q10. The Company’s “A” Issuer & Senior Debt rating reflect its status as a Critically Important Banking organization (CIB) in the United States. CIBs benefit from DBRS’s floor rating of “A” for bank holding companies and A (high) for banks with short-term ratings of R-1 (middle).

DBRS sees the Company’s quarterly financial results and overall financial profile as mixed. On one hand, core revenue and earning trends reflected weakness due to overall economic conditions with weak loan growth and a low interest rate environment coupled with the high costs of the regulatory reform and legacy mortgage issues, while credit costs remain elevated relative to historic levels. On the other hand, steadily improving credit quality, balance sheet de-risking and deleveraging, enhanced focus on its core businesses and improved capital and liquidity levels are positive developments for bondholders.

Company-wide net revenues were $26.9 billion, up 20% from 4Q10 primarily due to strong 1Q11 sales and trading results and the $3 billion GSE rep/warranty provision in 4Q10 while income before provisions and taxes (IBPT) increased 87% to $6.6 billion (excluding the 4Q10 $2.0 billion non-cash goodwill impairment charge). Net income, similarly, benefited from a 26% q-o-q decline in the provision for credit losses to $3.8 billion. Comparisons to 1Q10 were less favorable with net revenues declining 16% and IBPT down 54%, but provisions improving 61% reflecting 1Q10’s stronger spread business, trading and mortgage performances. The comparison to last year’s quarter highlights DBRS’s view of the Company’s struggle to improve core earnings in the current environment. DBRS also notes that 1Q11’s $2.2 billion reserve release and $1.1 billion in equity gains enabled Bank of America to remain profitable while absorbing significant losses related to its mortgage business.

Unsurprisingly, and a continuing concern for DBRS, Bank of America’s mortgage business again negatively influenced results with nearly $2.8 billion in increased rep/warranty provision, foreclosure delay and litigation expenses. Moreover, DBRS also expects material one-time charges and settlement costs from the FRB, OCC and State Attorney General investigations of its residential mortgage loan servicing and foreclosure practices over the next few quarters in addition to the incurred expense already embedded in its run-rate. The Company continues to address the legacy issues in its mortgage business as evidenced by its $1.6 billion Assured Guaranty agreement announced today; however, uncertainty surrounding its potential liability remains. DBRS notes that Bank of America did reiterate its $7 to $10 billion range of possible non-GSE rep/warranty loss (over current accruals) which could be absorbed over time through earnings, in DBRS’s opinion.

Despite further declines in the Company-wide allowance for loan losses, Bank of America’s reserves remain adequate in DBRS’s view. Loan loss reserves decreased for the third consecutive quarter to $39.8 billion (excluding the reserve for unfunded lending commitments) and were 126% of nonperforming assets (including foreclosed properties) and 4.29% of total loans and leases at 1Q11.

DBRS notes that credit quality continued to improve in the quarter. Company-wide net charge-offs (NCOs) were $6.0 billion for the fourth quarter (2.61% of average loans), an 11.1% decrease from 4Q10. This quarter’s results benefited from a $1.3 billion (26%) reduction in the provision for credit losses, which contributed to the $2.2 billion reduction in loan loss reserves. Underscoring the continued improvement, Bank of America reported its eighth consecutive quarter of declines in near-term consumer delinquencies (excluding FHA-insured loans) and its sixth consecutive quarterly decline in reservable criticized utilized exposures. Nonperforming loans (including foreclosed properties) declined for the third consecutive quarter, declining 3.1%, or $1.0 billion, from 4Q10 to $31.6 billion (or 3.40% of total loans, leases and REO) at March 31, 2011, while 90 day past dues (but still accruing and excluding FHA insured loans) fell $482 million, or 8.6%, to $5.1 billion.

Bank of America’s capital ratios continued to improve over the quarter as Tier 1 common was up 4 basis points (bps) to 8.64% and Tier 1 capital increased 8 basis points (bps) in the quarter to 11.32% benefiting primarily from a 1.6% decline in risk-weighted assets and both providing comfortable cushions above regulatory requirements. The Company’s tangible common equity ratio also rose 11 bps over the quarter to 6.10% and is moving closer to the range of its similarly rated peers. Bank of America’s senior management has clearly stated that it expects its Basel III Tier 1 common capital ratio will be at or above 8.0% by year-end 2012.

On March 18 the Federal Reserve indicated that it objected to the Company’s modest proposed 2H11 dividend increase. Bank of America intends to again seek permission for a modest increase in its common dividend for the second half of 2011, through the submission of a revised comprehensive capital plan to the Federal Reserve. DBRS sees the Company’s management of the CCAR process with regulators and communication of the results as disappointing, but notes that the interim retention of capital as positive for fixed income investors. The Company announced the creation of a new executive position to manage legal, compliance and regulatory affairs while also changing roles of the CFO and CRO effective by the end of 2Q11. DBRS notes that building regulator and investor confidence in its executive management team is essential for the Company’s ultimate success.

Liquidity and funding also continue to be enhanced with $386 billion in excess liquidity on its balance sheet (up approximately $50 billion in the quarter) and the benefit of strong deposit franchises within its diverse businesses. DBRS also notes that Bank of America reduced its long-term debt by $14.0 billion in 1Q11 to $434.4 billion, and is on target for a 15% to 20% reduction (relative to $478.9 billion at 3Q10) by year-end 2011 and a total $150 to $200 billion reduction by the end of 2013. The Company continues to maintain its robust deposit base as total average deposits were up 1.5% or $15.4 billion over the quarter to $1.023 trillion. Positively, the deposit mix improved with balance and yield declines in U.S. consumer CDs and IRAs contributing to a 3 basis point yield overall reduction to U.S. interest-bearing deposit yields. Also noteworthy was the 1.4%, or $4.0 billion, growth in average non-interest bearing deposits to almost $292 billion, which benefited the earning asset net interest yield by 17bp.

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

The principal applicable methodology is the Global Methodology for Rating Banks and Banking Organizations. Other methodologies used include the Enhanced Methodology for Bank Ratings – Intrinsic and Support Assessments, Rating Bank Subordinated Debt and Hybrid Instruments with Discretionary Payments, and Rating Bank Preferred Shares and Equivalent Hybrids, all of which can be found on the DBRS website under Methodologies.

The sources of information used for this rating include the company documents, the Federal Reserve, the Federal Deposit Insurance Corporation and SNL Financial. DBRS considers the information available to it for the purposes of providing this rating was of satisfactory quality.

Lead Analyst: William Schwartz
Approver: Roger Lister
Initial Rating Date: 16 May 2001
Most Recent Rating Update: 18 June 2010

For additional information on this rating, please refer to the linking document below.