DBRS Comments on Bank of America’s 1Q13 Earnings; Senior Debt Unchanged at “A”

DBRS, Inc. (DBRS) has commented today that its ratings for Bank of America Corporation (Bank of America or the Company), including its “A” Issuer & Senior Debt rating, are unchanged following the announcement of the Company’s 1Q13 results. The trend on all ratings is Stable. 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). Given the nature of the rating floor, these ratings have Stable trends. Bank of America’s intrinsic assessment (IA) is currently one notch below its final rating or A (low).

Bank of America reported higher net income of $2.6 billion for the quarter, up markedly from $732 million in 4Q12 and $653 million in 1Q12. Improved net income in the quarter primarily reflected lower DVA/FVO adjustments, better market-generated revenues, absence of the Independent Foreclosure Review acceleration agreement, and lower legacy asset & servicing expenses that were partially offset by higher seasonal compensation expenses. In DBRS’s opinion, Bank of America’s 1Q13 financial performance reflected some good trends, improved credit metrics, and a pending settlement on Countrywide RMBS securities. Quarterly disclosures also underscored, however, that the Company’s performance remains pressured by high expenses, especially litigation, and elevated legacy costs. Positively, the Company continues to make incremental progress in putting its legacy issues behind it. DBRS believes that Bank of America will continue to absorb elevated costs primarily related to its legacy mortgage business over the medium term through earnings. Meanwhile, the Company’s challenge is to grow core revenue in a difficult operating environment featuring low interest rates, constrained capital markets activity, increased competition, and expense pressure. The Company was able to generate positive operating leverage in the quarter (adjusted to exclude one-time items) even including $893 million in first quarter seasonal stock-based compensation costs, as the “New BAC” expense reductions appear to be taking hold. While DBRS is also cognizant of improvements in Bank of America’s balance sheet, the Company’s core earnings power and franchise strength, which remain challenged, are key drivers for its intrinsic rating level.

Positively, for fixed income investors, the Company continued to strengthen its balance sheet with improved capital levels, ample liquidity, better asset quality, and reduced litigation exposure. In DBRS’s opinion, the tentative Countrywide RMBS settlement will further reduce uncertainty for the Company helping it to move forward, if approved by the court.

DBRS-adjusted Company-wide net 1Q13 revenues were $23.6 billion, up 26% from 4Q12 and up 5.5% from 1Q12. Adjusted for one-time gains and unusual expenses, income before provisions and taxes (IBPT; DBRS’s core earnings power metric) was $5.7 billion, a 25.2% improvement from 4Q12 and 9.4% better than 1Q12, primarily reflecting expense savings. DBRS notes that the loan loss provision, down to $1.7 billion in the quarter, accounted for a modestly elevated 30% of IBPT in 1Q13 and highlights the healthiest relationship between revenue and credit costs since 1Q08.

Reflecting positively on underlying business trends, revenue improved in five of the six business segments in the quarter with Consumer & Business Banking essentially flat. Pre-tax income was up QoQ in four of the six segments with the exception of Global Banking and All Other, both primarily driven by seasonal compensation expenses. Positive trends included continued good deposit growth in Consumer & Business Banking, strong growth in Global Wealth & Investment Management featuring another quarter of strong client investment activity, and solid Global Banking results from strong commercial loan growth, although deposits declined. A rebound in FICC revenues, better trading performance, and higher volume over the quarter resulted in improved Global Markets performance. Nonetheless, Global Banking results were weaker compared to a very strong 1Q12. Bank of America also enhanced its second place ranking in net global investment banking revenues during 1Q13 with a 7.8% market share (up from 6.6% FY2012) and maintained top tier rankings across many products.

DBRS-adjusted expenses rose 7.0% over the quarter excluding 4Q12’s $1.1 billion IFR settlement and the $300 million FNMA fee provision charges primarily from the higher first quarter stock-based compensation and revenue-based incentive compensation. The $18.2 billion expense level, however, was a 5.2% decline from the previous year primarily reflecting cost savings from Project New BAC. Management continues to guide for material savings by FYE2013 including at least an additional $500 million in Legacy Assets & Servicing. DBRS notes that some tangible indicators of cost cuts include a 5.7% reduction in FTE headcount over the year and a 262, or 4.6%, branch decline through closings or sales.

Mortgage banking income rebounded to $1.3 billion following a $540 million loss in 4Q12, as the $250 million 1Q13 rep and warranty provision normalized compared to the $3.0 billion incurred in 4Q12. Despite exiting correspondent originations in 4Q11, loan production continued to ramp up growing 11% over the quarter and 57% over the year. DBRS notes that the Company added 812 mortgage officers over the past year to help grow the business. Core production revenue fell a steep 17%, however, to $815 million over the quarter and 12% over the year, primarily due to gain on sale margin compression, which DBRS expects to continue. Mortgage servicing fees also declined $183 million over the quarter and are expected to decline another $100 million by YE2013, as Bank of America completes a number of MSR sales. Overall, the servicing portfolio of 6.5 million loans is down 27% from 1Q12.

The Company announced a pending settlement of three Countrywide RMBS security lawsuits for a $500 million payment. If approved, the Company will have resolved over 70% (based on unpaid principal balance - UPB) of the filed or threatened RMBS lawsuits (80% of Countrywide UPB). Moreover, the Company has already fully reserved for the payment in its litigation reserves.

Overall, the rep/warranty reserve decreased $4.9 billion, or 26%, to $14.1 billion in 1Q13 primarily due to the 4Q12 FNMA settlement. After the FNMA settlement, Bank of America’s new and outstanding rep/warranty claims have dropped precipitously, which should reduce future rep/warranty provisioning needs. Nonetheless, additional future settlements could still generate lumpy results. Additionally, the Company maintained its reasonable estimate of a range of possible loss (RPL) for rep/warranty exposures at up to $4 billion (primarily for non-GSE exposure) above current accruals. DBRS notes that while uncertainly remains as to the final cost of resolving the remaining private and monoline exposures, litigation and pending settlements, the Company has removed a substantial amount of uncertainty around its litigation and rep/warranty exposures.

During the quarter, credit quality continued to improve at a good pace across most asset classes and Company-wide net charge-offs (NCOs) were down almost 19% over the quarter at $2.5 billion (1.14% of average loans, down 26 bps). Given the improvement, Bank of America released $804 million in reserves, as the provision for credit loss decreased $491 million (22%) to $1.7 billion. DBRS notes that this was below the Company-guided $1.8 billion to $2.2 billion range for 2013 quarterly provisions. DBRS also believes that asset classes such as commercial loans and credit cards with NCO rates of 0.25% and 4.19% respectively, are performing at unsustainably favorable levels while consumer mortgage performance will need more time to normalize. Bank of America reported another quarterly decline in near-term U.S. credit card delinquencies and its fourteenth consecutive quarterly decline in commercial reservable criticized utilized exposures, which were down 5.8%. Meanwhile, non-performing assets declined 3.0%, or $713 million to 22.8 billion, and 90 day past dues (but still accruing and excluding fully-insured loans) fell $229 million or 9.4% to $2.2 billion.

Despite further declines in the allowance for loan losses, Bank of America’s reserves remain adequate in DBRS’s view. DBRS notes that two less likely risk events, namely a double digit or larger decline in residential real estate values over the next 12 months, or a significantly deteriorating crisis in Europe, would likely change this view. As a result of improving credit quality, loan loss reserves decreased for the eleventh consecutive quarter to $22.4 billion (excluding the reserve for unfunded lending commitments), or 102% of non-performing assets and 2.49% of total loans and leases at 1Q13, down from 107% and 2.69%, respectively, at 4Q12. The Company disclosed $14.5 billion in total exposure (unchanged from 4Q12) to Greece, Ireland, Italy, Portugal and Spain. After considering $5.9 billion (up from $5.1 billion at 4Q12) in related counterparty hedges and credit default protection, the Company’s net exposure was $8.6 billion (down from $9.5 billion at 4Q12). DBRS perceives this risk as relatively manageable at current levels given that the exposure is primarily cross-border exposure to corporate entities. Nonetheless, a more severe European crisis would likely produce significant credit costs.

Bank of America continued to grow its capital level through earnings retention, but risk-weighted assets increased, as the Company implemented final market risk rules. Specifically, the Company’s Basel I Tier 1 common ratio was 10.58% at 1Q13, or 20 bps above the proforma 4Q12 figure (if the final market rules were included), while the tangible common equity ratio also increased 20 bps over the quarter to 6.94%. Bank of America estimated its fully phased-in Basel III Tier 1 Common Equity Ratio to be 9.42% including the most recent proposal (NPR), an improvement from 4Q12’s 9.25%.

In March, the Federal Reserve announced its results for the Comprehensive Capital Analysis and Review (CCAR). Under the severely adverse scenario, Bank of America Corporation’s Tier 1 common and leverage ratios were 6.04% and 4.62%, respectively, at their minimums (including capital distributions) and the Fed did not object to its planned capital actions. The Company subsequently announced the authorization to repurchase up to $5.0 billion of common stock and the redemption of approximately $5.5 billion in preferred stock. Bank of America’s 2013 capital plan did not include a request to increase the quarterly common stock dividend rate of $0.01 per share.

Liquidity and funding also continue to be maintained at substantial levels with $372 billion in global excess liquidity on Bank of America’s balance sheet (flat over the quarter). Moreover, the Company benefits from having strong deposit franchises within its diverse businesses, which generally continue to experience significant inflows. Lastly, the time to required funding declined to 30 months (with parent company excess liquidity at $100 billion) from 33 months in the quarter as the Company again reiterated that it intends to maintain at above 24 months. DBRS also notes that while Bank of America increased its 1Q13 long-term debt (LTD) by $4 billion to $280 billion as it opportunistically pre-funded a portion of its 2013 funding plans, it expects LTD to decline over the rest of 2013 and 2014.

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

[Amended on May the 23rd, 2014 to remove unnecessary disclosures.]