DBRS: BAC’s Solid 3Q; Continued Core Business Momentum

Summary:
• BAC reported 3Q net income of $4.5 billion, down from 2Q, but up materially from 3Q14 when the Company incurred litigation expense of $6.0 billion.
• Credit fundamentals continue to improve with solid core loan and deposit growth, higher capital levels, still improving asset quality, and increased liquidity.
• DBRS rates Bank of America Corporation’s Issuer & Senior Debt at A (low) with a Stable trend.

DBRS, Inc. (DBRS) views Bank of America Corporation’s (BAC or the Company) 3Q15 financial results as solid with improving credit fundamentals. Specifically, BAC delivered solid core loan and deposit growth, higher capital levels, still improving asset quality, and increased liquidity. After primarily focusing on cutting expenses and optimizing the balance sheet, the Company is now investing in growth opportunities, while keeping core expenses relatively stable. Investments in the businesses include the hiring of mortgage loan officers, small business bankers, financial solutions advisors and wealth advisors. As a result, core loans are growing and the Company just reported its 25th consecutive quarter of positive long-term assets under management flows in Global Wealth and Investment Management business. These investments should enable the Company to grow revenues, which remains the key challenge at BAC.

Total loans and leases grew sequentially. Moreover, for the second consecutive quarter, organic loan and lease growth has more than offset run-off in the Legacy Assets and Servicing portfolio. Net interest income (excluding the impact of market-related adjustments), grew modestly sequentially, which could mark a key inflection point for revenue growth even if rates remain unchanged. Nonetheless, BAC would benefit from higher interest rates with a 100 bps parallel shift rise in the yield curve growing net interest income by $4.5 billion over the next 12 months.

Considering the environment, Global Markets performed well with relatively modest revenue declines both quarter-over-quarter (QoQ) and year-over-year (YoY). Nonetheless, net income of $1 billion was higher reflecting lower expenses. Fixed income, currencies and commodities revenues declined 11% YoY driven by weaker credit-related businesses, although rates products did improve. Meanwhile, Equities revenue increased 12% YoY primarily reflecting strong performance in derivatives. The business mix remains more heavily weighted toward credit products.

Core expenses remain well controlled even with added investments in the businesses. Excluding litigation expense, expenses were down 4% YoY and were relatively stable QoQ. As a result, BAC was able to generate positive operating leverage YoY, but not QoQ. The Company noted that if it failed to generate sufficient revenue growth, it would cut back on investments in the business.

Asset quality remains strong with broad-based improvements in the consumer portfolio more than offsetting some deterioration in the oil and gas portfolio. While reservable criticized commercial loans did increase during the quarter as deterioration in oil and gas was partially offset by improvements in the rest of the commercial portfolio, the pace of deterioration slowed. Management guided towards provisioning needs of between $800 million and $900 million per quarter in 2016.

The Company built both capital metrics and liquidity during the quarter, which are both at record levels. DBRS notes that BAC resubmitted its CCAR at the end of the quarter and expects a response from the regulators within 75 days. BAC received approval to begin using the Advanced approaches framework to determine risk-based capital starting in 4Q. The regulators requested modifications to certain internal analytical models, which increases RWAs. As a result, the Company’s fully phased in CET1 ratio under the advanced approach would have declined to 9.7% using the new models compared to 11.0% under the previous models.

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.