DBRS: BAC’s 3Q14 Positive Underlying Business Momentum Masked By Outsized Mortgage Settlement

Summary:
• 3Q14 net income (to common) of $168 million driven by further sizable litigation expenses of $5.6 billion; $4.9 billion of which was associated with the previously announced DOJ settlement that significantly reduced exposures to legacy issues.
• Excluding the litigation expense, the core businesses continue to generally show positive momentum reflected in underlying metrics.
• 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) 3Q14 earnings were largely eliminated by expenses associated with the DOJ mortgage settlement, which mask some solid underlying performance. DBRS notes that Company efforts to address legacy issues have increased litigation expenses $14.7 billion in 2014 YTD alone, and are likely to remain a headwind over the intermediate term. Nonetheless, DBRS sees BAC’s remaining legal issues as generally far less material than those now in the rear view mirror.

Looking beyond the settlement’s financial impact, DBRS views positive underlying business momentum in BAC’s operating business segments with the exception of Consumer Real Estate Services. The Consumer & Business Banking (CBB), Global Wealth & Investment Management (GWIM), Global Banking and Global Markets (GM) businesses have all grown revenue, pre-tax pre-provision earnings and net income year-over-year (YoY). Moreover, the Consumer & Business Banking (CBB) and GWIM businesses have returns on allocated capital above 25% in the quarter, highlighting strong performance.

Addressing risks in the interest rate environment, credit and enhancing liquidity, the Company took a number of balance sheet actions in 3Q14 that resulted in a modest balance sheet contraction, which DBRS views as prudent and aiding LCR compliance. Bank of America converted residential mortgage loans into securities and also reinvested proceeds from loan sales and paydowns into securities. Additionally, it reduced trading securities and low-yielding prime brokerage loans in GM. Moreover, the Company reduced less LCR-friendly deposits.

Asset quality continued to reflect improvement, albeit at a slower pace, as was expected. The $636 million credit loss provision included $400 million related to the DOJ settlement, but otherwise would have been significantly below the 2Q14 level. The $807 million (ex-DOJ related increase) reserve release was up over the quarter but future releases are expected to moderate. DBRS sees the loan loss allowance as providing ample protection against potential losses.

Demonstrating the strength of its global banking franchise, BAC reported good investment banking revenues benefitting from higher advisory fees, which partially offset the moderation in equity underwriting fees following a strong 2Q. Meanwhile, markets businesses were weaker QoQ, but performed better than 3Q13, excluding DVA and the U.K. tax change. Specifically, both equity and FICC revenues increased in the YoY quarter comparison. DBRS notes that average trading-related assets were roughly flat while VAR declined over the quarter.

BAC’s financial profile remains solid with growing liquidity and estimated fully phased-in Basel III Common Equity Tier 1 ratios of 9.6% under the standardized and advanced approaches, and an approximate supplementary leverage ratio of 5.5% at the holding company-level and 6.8% at the bank level. Moreover, LCR is at 110% at the parent and over 80% at the bank level. The Company anticipates the bank level LCR to be at 100% in 1Q15.

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

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