DBRS Comments on Bank of America’s 2Q11 Earnings; Senior Debt Unchanged at “A”

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 2Q11 results. The trend on all ratings is Stable. As expected, Bank of America reported a sizable loss of $8.8 billion for the second quarter compared to net income of $2.0 billion in 1Q11 and $3.1 billion in 2Q10. 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).

Today’s quarterly earnings announcement reflected how the large costs embedded in resolving the Company’s mortgage-related exposures are overshadowing the earnings potential of its underlying businesses. On June 30, 2011 DBRS confirmed the Company’s ratings after the announcement of an $8.5 billion settlement agreement covering nearly all of Countrywide’s first-lien private label securitized mortgage repurchase exposures. Bank of America also recorded an additional $5.5 billion of 2Q11 representation and warranty provision, $4.0 billion in mortgage-related charges and the write-off of the remaining $2.6 billion of Consumer Real Estate Service business goodwill. In DBRS’s view, the short-term negative financial impact of the announcement was offset by its medium to long-term benefits.

DBRS also expects material one-time charges and settlement costs from the FRB, OCC and State Attorney General ongoing investigations of its residential mortgage loan servicing and foreclosure practices over the next few quarters that are currently in negotiation. Bank of America reiterated its $5 billion estimate of possible additional non-GSE rep/warranty loss (over current accruals and not including litigation losses). While the total cost of resolving all of the mortgage-related exposures remains uncertain and management has underestimated potential losses before, the settlement agreement signaled that there is progress through a painful, yet absorbable loss in DBRS’s opinion.

The large quarterly loss precipitated a $9.2 billion or 41 basis point (bps) decline in Tier 1 Common Capital ratio to 8.23%. The drop in the ratio, after a year of growing, would have been greater were it not for the nearly $41 billion drop in risk-weighted assets as the Company continues to reduce capital intensive assets to optimize capital while preparing for Basel III compliance. Similarly, the Company’s tangible common equity ratio declined 23 bps over the quarter to 5.87% after climbing for a year to 6.10% in 1Q11. Bank of America’s management reiterated its expectation that all capital ratios will be in excess of regulatory minimums by the respective phase-in dates. DBRS is mindful of both the progress and the remaining risks for the Company and will be monitoring progress and capital market support through this process. Difficulty in building its capital base or erosion of capital market support could pressure Bank of America’s intrinsic assessment (IA) rating.

Company-wide net revenues were $13.2 billion, down 51% from 1Q11 and 55% from 2Q10 primarily due to mortgage-related charges. The record net income loss of $8.8 billion was somewhat buffered by $2.6 billion in asset sales, security gains and an impairment along with a $559 million sequential quarter decline in loan loss provisions. Adjusted for the mortgage-related charges, expenses, goodwill impairment and asset sale gains, pre-tax pre-provision income would have been $8.9 billion and net income $3.7 billion. This reinforces DBRS’s view of the Company’s latent earnings potential that is being masked by its legacy mortgage issues. DBRS also notes that improving credit quality enabled 2Q11’s $2.5 billion reserve release.

Outside of Consumer Real Estate Services (Mortgage), the Company’s business segments generally performed well in the second quarter. Of particular note was another strong quarter for Global Banking and Markets with $1.6 billion in net income following the exceptional $2.1 billion in 1Q11 with strong investment banking fees and good Sales and Trading revenue (although down from 1Q11). Global Card Services continues to recover with $2.0 billion in net income for the quarter with sharply lower provisions coupled with good purchase volume and account growth. Global Commercial Banking also benefited from better asset quality and stronger revenue despite the runoff of $2.2 billion in commercial real estate. Global Wealth & Investment Management continued to produce good results off of a record 1Q11 with good long-term AUM flows and loan growth.

Despite further declines in the Company-wide allowance for loan losses, Bank of America’s reserves remain adequate in DBRS’s view. Two less likely risk events, a double digit or larger decline in residential real estate values over the next 12 months or a larger-than-expected crisis in Europe could change that view. Loan loss reserves decreased for the fourth consecutive quarter to $37.3 billion (excluding the reserve for unfunded lending commitments) and were 124% of non-performing assets (including foreclosed properties) and 4.00% of total loans and leases at 2Q11.

DBRS notes that credit quality improved at a good pace in the quarter. Company-wide net charge-offs (NCOs) were $5.7 billion for the second quarter (2.44% of average loans), a 6.0% decrease from 1Q11. This quarter’s results benefited from a $559 million (15%) reduction in the provision for credit losses which contributed to the $2.5 billion reduction in loan loss reserves. Underscoring the continued improvement, Bank of America reported its ninth consecutive quarter of declines in near-term consumer delinquencies (excluding FHA-insured loans) and its seven quarter consecutive decline in reservable criticized utilized exposures. Non-performing loans (including foreclosed properties) declined for the fourth consecutive quarter, declining 5.0% or $1.6 billion from 1Q11 to $30.1 billion (or 3.22% of total loans, leases and REO) at June 30, 2011 while 90 day past dues (but still accruing and excluding FHA insured loans) fell $886 million or 17.3% to $4.2 billion.

The Company disclosed $16.7 billion total exposure to selected European countries (Greece, Ireland, Italy, Portugal and Spain) before $1.8 billion in counterparty hedges. DBRS perceives this risk as relatively manageable currently given that the exposure is primarily cross-border exposure to corporate entities.

Liquidity and funding also continue to be enhanced with $402 billion in global excess liquidity on its balance sheet (up approximately $16 billion in the quarter and $109 billion over the year) and the benefit of strong deposit franchises within its diverse businesses. DBRS also notes that Bank of America has reduced its long-term debt by $7.8 billion in 2Q11 to $426.7 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’s continues to maintain its robust deposit base as total average deposits were up 1.25% or $12.8 billion over the quarter to $1.036 trillion. Also noteworthy was the 3.5% or $10.1 billion growth in average non-interest bearing deposits to almost $302 billion which benefited the earning asset net interest yield by 19bps or up 2bps over the quarter.

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: 30 June 2011

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