DBRS: Legacy Issues a Challenge at Bank of America, Distracting from Positive Franchise Momentum

Summary:
• 1Q14 net loss (to common) of $276 million driven by sizable litigation expense of $6.0 billion, with $2.4 billion contributing to reserves
• While legacy issues remain a challenge, the core businesses continue to show positive momentum reflected in underlying earnings
• DBRS rates Bank of America Corporation’s Issuer & Senior debt at A (low) with a Stable trend

In DBRS, Inc.’s (DBRS) view, Bank of America Corporation’s (BAC or the Company) 1Q14 earnings demonstrate positive franchise momentum, particularly in the capital markets and wealth management businesses, highlighting the benefits of the Merrill Lynch acquisition. Supporting its funding profile, the Company continues to generate deposits, reaching a sizable $1.13 trillion (close to 60% of total liabilities), but the challenge remains in prudently deploying these deposits. In considering its risk appetite and expected returns, BAC has been growing its commercial lending book, while the consumer loan book continues to decline. Importantly, the Company’s powerful underlying franchise contributes to the generation of solid income before provisions and taxes (IBPT), excluding litigation costs, allowing it to absorb credit costs and generate core underlying earnings.

Overwhelming this quarter’s results was the additional litigation expense of $6.0 billion. With $3.6 billion related to a settlement with the Federal Housing Finance Agency in the quarter, the remaining balance was an addition to reserves for legacy matters. DBRS views positively the Company’s willingness to reduce the uncertainty factor around the potential cost of legacy issues by working through various settlements and taking steps to mitigate the potential future cost by adding to its reserves. DBRS views the invasion of capital from the loss as minimal and, generally, capital levels remain solid.

Demonstrating the strength of its global capital markets franchise, BAC reported strong investment banking revenues, supported by its strong position in debt capital markets, and solid sales and trading revenues in what has proven to be a difficult 1Q across the industry. Looking ahead, DBRS expects that lower client activity levels will likely continue to pressure net revenues sector-wide. Across the industry, profitability and returns are also pressured by increased compliance costs, as well as liquidity/capital requirements, as the industry adjusts to the still challenging regulatory environment.

In another standout quarter, Global Wealth & Investment Management (GWIM) continues to grow revenues driven by record asset management fees. Client balances of $2.4 trillion reached record levels. With controlled expenses, the Company maintained a solid pre-tax margin of 25.6% in GWIM.

BAC’s financial profile remains solid with an estimated Basel III Tier 1 (T1) common ratio of 9.3%, under the standardized approach, and an estimated supplementary leverage ratio in excess of the 5% requirement at the holding company-level.

DBRS rates Bank of America Corporation’s Issuer & Senior debt at A (low) with a Stable trend.

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

[Amended on December 23th, 2014 to remove unnecessary disclosures.]