Bank of America (BAC) Q2 2013 Earnings Call July 17, 2013 8:30 AM ET
Lee McEntire - Investor Relations
Brian Moynihan - President and CEO
Bruce Thompson - Chief Financial Officer
Betsy Graseck - Morgan Stanley
Matt O’Connor - Deutsche Bank
John McDonald - Sanford Bernstein
Brennan Hawken - UBS
Paul Miller - FBR Capital Markets
Guy Moszkowski - Autonomous Research
Chris Kotowski - Oppenheimer
Moshe Orenbuch - Credit Suisse
Nancy Bush - NAB Research
Mike Mayo - CLSA
Welcome to today’s program. [Operator instructions.] It’s now my pleasure to turn the program over to Lee McEntire. Please begin, sir.
Good morning to those on the phone or joining us by webcast. Before Bruce Thompson and Brian Moynihan begin their comments, let me remind you that this presentation, available at bankofamerica.com does contain some forward-looking statements regarding both our financial condition and financial results, and that these statements involve certain risks that may cause actual results in the future to be different from our current expectations. And please see our press release and SEC documents for further information.
With that, let me turn it over to our CEO, Brian Monynihan.
Thank you, Lee. Good morning everyone, and just to start off, let me remind you of what our focus is and has been for some time: on capital generation, on managing our risk, on continuing to reduce our costs, and on addressing the legacy issues so that we can drive our growth strategy by simply doing more with our customers and clients.
This quarter shows very clearly how the focus is paying off, as we earned $4 billion. We built our company over the last several quarters to maintain stability, and we’ll continue to make progress to withstand the volatility that we saw in part again this quarter while delivering for our customers and shareholders.
And that came true, even as mortgage demand has decreased, we still had a 40% increase in retail production over last year, and an increase over the last quarter. Even as interest rates rose, we were able to add to our capital ratios. And keep in mind, with our trillion-dollar deposit book, rising rates will continue to increase the value of those over time.
We have leading capabilities in the areas where our customers want us to be. We do more business with them and we’re gaining momentum across every customer group. And while we’re doing that, our balance sheet continues to strengthen, our capital ratio has again moved higher, and just as importantly, we’ve begun the process of returning capital to our shareholders.
Our credit quality continues to improve. Expenses are down by $1 billion from a year ago. LAS, or Legacy Asset Servicing, expenses, excluding our litigation, are down by nearly $800 million on a quarterly basis, from the peak only a couple of quarters ago, and are ahead of our projections.
Our loans and our deposits continue to grow. All the businesses produced solid, stable revenues in the focus areas where we are growing that grew their revenues. And we’re seeing growing activity levels across all our customer and client groups.
So as we look forward, we’re closely following recent regulatory proposals around capital and leverage, just as you are. Obviously we have already taken significant steps in our company to build our current strong levels of capital and liquidity, and we maintain a comfort level here that Bruce will take you through the numbers later.
The good news in all this is that we’re seeing in our business as reflected in our improved economy. The economy continues to improve across all areas. That benefits our company across multiple fronts, but most importantly, with an improving economy, it strengthens and creates opportunity for the people, companies, and investors that we serve, and that opportunity will continue to provide opportunity for us to capture and to connect all our capabilities to help those that we serve realize their financial goals.
With that, let me turn it over to Bruce.
Thanks, Brian, and good morning everyone. I’m going to start on slide five of our presentation materials. Total revenues for the quarter were very solid at $22.9 billion, and we earned $4 billion, or $0.32 per diluted share, which is up significantly both from the first quarter of this year as well as the comparable period in 2012.
We made significant progress in all of our primary businesses this quarter, and on a linked quarter basis, we had growth in four out of the five businesses. Consumer activity levels were solid, as mortgage production increased, credit card loan balances stabilized, and both deposits and brokerage flows increased from the previous quarter.
Global wealth and investment management reported another quarter of record revenues, as well as earnings. Global banking revenue showed continue strength, driven by increased lending in both our commercial as well as our corporate bank, and investment banking performance remained strong and close to record levels.
Total noninterest expense of $16 billion represented a significant improvement in expenses, both relative to the first quarter of this year as well as the comparable quarter in 2012, and asset quality improved significantly as our provision expense declined to $1.2 billion this quarter.
On slide six, we give some balance sheet highlights. First, the overall size of the balance sheet came down this quarter to about $2.125 trillion. Importantly, customer activity remained strong, with loans, led by our commercial loans, up $10 billion.
Period end deposits were down, driven by seasonality associated with tax payments. However, our average deposits did experience modest growth. And also call out on the page the tangible book value per share remained relatively flat from the first quarter of this year. That’s significant in the context of our $4 billion of earnings largely offset the negative after-tax impact from accumulated other comprehensive income, driven by the increase in rates that we saw during the quarter.
Also helping our tangible book value per share in the quarter was the return of roughly $1 billion of capital through the repurchase of 80 million common shares at a price below tangible book value. And as we look forward, we have an additional $4 billion available for common share repurchases.
The combination of the earnings that I discussed on slide five, as well as the work that we did on our balance sheet, led to a return on tangible common equity of just under 10% for the quarter, and a return on average assets of 74 basis points.
On slide 7, we walk through some of the different regulatory capital ratios as far as where we ended up at the end of the second quarter. If we start with Basel 1 tier one common ratio, we ended the quarter at 10.83%, up 34 basis points from the first quarter of this year and 45 basis points on a pro forma basis at the end of 2012.
Moving to Basel III, fully phased in basis under the advanced approach, and based on final rules, our tier one common ratio was 9.6%, showing progress from the first quarter of ’13, despite a 32 basis point negative impact from the change in OCI during the quarter.
Risk-weighted assets under Basel III were $1.31 trillion, or $43 billion lower than the first quarter of ’13, due to an improvement in both the composition as well as the overall credit quality on the books.
If we move to the proposed supplementary U.S. leverage ratio requirement, which will kick in at the beginning of 2018, our preliminary analysis indicates that at the holding company, our leverage ratio for the second quarter of 2013 was in the range of 4.9% to 5%, which positions us very well relative to the 5% minimum.
If we look at our primary bank subsidiaries, which we have two, BANA, our primary banking subsidiary, and FIA, our card subsidiary, during the second quarter of 2013, both of those were in excess of the 6% proposed minimum. So net-net, from a regulatory capital perspective, we feel like we’ve made very good progress across all of the different measures that will be required to operate within.
On page eight, funding and liquidity, you can see long term debt during the quarter declined $18 billion, as maturities outpaced issuances during the quarter. Our global excess liquidity sources did decline during the quarter. It was expected as a result of our reductions in the long term debt footprint, our preferred stock redemptions, as well as the seasonal deposit outflows that I referenced earlier from tax payments.
At the parent company, liquidity remains very strong at $95 billion, due to capital returns from our subsidiaries during the quarter. Time to required funding increased to 32 months, up from 29 months in the first quarter of ’13, and well above our target of approximately 24 months. And as we’ve indicated before, over the next four to six quarters, we will look to move that time to funding towards the 24 months as we repay the upcoming debt maturities in 2013 and 2014.
On net interest income, if you look at slide 9, net interest income on an FTE basis was $10.8 billion, down just about 1% from the first quarter of 2013. If you adjust our net interest income for market-related items, it was $10.4 billion, which was less than $100 million below our guidance, as our trading-related net interest income declined as a result of reduced balance sheet utilization in our global markets business during the last month of the quarter.
On the positive side, we benefited during the quarter from lower long term debt, higher levels of commercial loan balances, as well as one additional day of interest in the second quarter relates to the first. On the flipside, in addition to the negative impact of lower asset balances on the trading books, we also had slightly lower consumer loan balances and yields, driven by our runoff portfolios.
As we came into the second quarter of 2013, our interest rate sensitivity as we disclosed in the first quarter 10-Q, estimated a $1.6 billion annual benefit to net interest income from a 100 basis point instantaneous [long end] steepening if rates remained at that level.
During the second quarter, the 10-year rate did increase by more than 60 basis points, and we realized $300 million of that benefit immediately through the impact on FAS 91. We expect to realize the balance of the benefit, approximately $700 million, over the course of the next 12 months.
As a result of those different factors, we do expect net interest income, excluding any market related impacts, to build off of the second quarter of 2013’s $10.4 billion adjusted level as we move forward during the balance of 2013 and into 2014.
If you look at the work that we did on expenses, on slide 10, total expenses were down significantly, on both a linked quarter as well as a year over year basis as we continued to deliver on the expense reductions that we discussed within our legacy assets and servicing area, as well as the ongoing cost savings from our new BAC initiatives that we’re implementing in the other businesses that we operate.
Our number of full-time equivalent employees in the quarter ended at just over 257,000, which was down 2% from the first quarter of 2013 and almost 7% from the comparable period a year ago.
Total expenses did decline $3.5 billion from the first quarter of ’13 as we benefited from a $1.7 billion decline in litigation. Our LAS expenses ex-litigation were down roughly another $250 million. Our retirement eligible costs, which we only incur during the first quarter of each year, were down $900 million, and all other expenses were down approximately $600 million.
As we look at the progress that we make on our LAS expenses, from the fourth quarter of 2012, when they peaked at $3.1 billion, we are now down approximately $800 million from that peak. And we did all of that within the last two quarters.
As a result, we previously had said that our LAS expenses, ex-litigation, would be approximately $2.1 billion by the end of 2013, meaning in the fourth quarter of 2013, and with the progress that we’ve made, we now believe our fourth quarter LAS expenses will be below $2 billion in the fourth quarter of ’13.
And keep in mind that as we work through these, the realization of these savings can be somewhat lumpy. In addition to our LAS expenses, the $600 million improvement in all other cost was driven primarily by lowering incentive compensation costs during the quarter as well as our new BAC efforts. We remain on track to achieve $1.5 billion of new BAC quarterly savings by the fourth quarter of 2013.
On slide 11, we give some information on the trends from an asset quality perspective, and as you can see, credit quality once again improved significantly during the quarter. Net chargeoffs declined to $2.1 billion, an improvement of 16% on a linked quarter basis, and 42% relative to the second quarter of 2012.
Our second quarter of 2013 net loss rate of 94 basis points is the first time that we’ve been below 100 basis points since 2006. Given the improving trend in delinquencies and other metrics, we now expect our net chargeoffs will come in below $2 billion in the third quarter of 2013.
Provision expense of $1.2 billion this quarter does reflect a reserve reduction of approximately $900 million, reflecting improving credit trends. The allowance coverage remains strong, and given the pace of improvement in credit quality, we do anticipate continued reserve releases, particularly in our consumer real estate portfolios.
Let’s now move to a discussion of the performance within our lines of business on slide 12. Before we go through the results, I do want to highlight a technical change that this quarter we did move our direct and indirect auto and other specialty lending into the CPB business from global banking given that it more closely connects with consumer lending activity. This book does include $37 billion of loans, and we have adjusted prior periods to have this data be comparable.
Earnings in the business were relatively stable compared to the first quarter of ’13, and up 15% from the prior year, driven by both expense improvements as well as lower credit costs. We do continue to do more business with our core customers.
Our average deposits were up almost $9 billion from the first quarter of ’13, excluding the transfers that we had from the wealth management business. Loans declined a modest 1% as a decline in our credit cards was mitigated by our balance growth in both small business as well as auto lending.
There’s been a lot of discussion on our U.S. credit card balances. Those balances appear to have stabilized and at the end of the second quarter were at $90.5 billion, up from $90 billion at the end of the first quarter of this year. Our card issuance remains strong in the second quarter, and is at its highest level since 2008.
U.S. consumer credit card retail spend for average active account was up 9% from the same quarter a year ago. We continue to optimize our delivery network, and usage within the mobile channel continues to increase. And lastly, expense levels reflect both the benefits of the network optimization as well as the investments to build out our specialty sales force.
If we move to consumer real estate services, on slide 13, we address home loans, one of the two businesses within our CRES segment. First mortgage retail originations were $25 billion and were up 6% from the first quarter and 41% compared with retail originations in the year ago period.
Our market share in the retail mortgage space improved. We broke through 5% versus below 4% just over a year ago. We do anticipate some slowdown in mortgage production resulting from recent increases in interest rate, and that is seen by the 5% reduction in our mortgage origination pipeline at the end of June relative to what we had seen at the end of March this year.
While production has experienced a nice trajectory over the last year, we, like the industry, have experienced compression on margins that affects revenue. While these margins do remain high relative to historical periods, the compression is most notable when you look at our year over year production revenue.
We continued to add mortgage loan officers during the second quarter, primarily in the banking centers, as well as other employees in our sales and fulfillment area, in order to deliver a first class mortgage experience for our customers. These actions did contribute to higher expenses in the quarter.
On slide 14, we moved to legacy assets and servicing, which still did report a loss in the quarter, but showed significant improvement from the first quarter, which included the MBIA and RMBS litigation settlements as the reduction in expenses more than offset a decline in the revenues.
Revenues were negatively impacted by a servicing revenue decline of $175 million, as the servicing portfolio declined 17% and we had less favorable MSR hedge performance. That was partially offset by higher sales volume of loans that returned to performing status.
As you look at LAS, several key takeaways from this slide. The first is our level of 60-plus day delinquent loans, which is one of the primary drivers of the elevated cost, dropped below 500,000 units at the end of June, a 27% decline from the results at the end of the first quarter of ’13.
Recall our number of 60-plus day delinquent loans peaked at almost 1.4 million units at the end of 2010. Looking ahead, we now expect our amount of 60-plus day delinquent loans to come down further than we originally expected to below 375,000 units by the end of 2013. As we continue to reduce these loans, the number of employees and contractors will come down, and you can see that by the decrease of 5,000 people during this quarter.
Expenses, ex-litigation, once again were down roughly $250 million from the first quarter to $2.3 billion.
Global wealth and investment management, on slide 15, had a great quarter, with our results once again reflecting records in revenues, earnings, as well as pretax margin. Year over year, revenue increased 10%, and net income grew by 38%.
Our second quarter pretax margin of about 28% benefited from strong revenue performance as well as improved credit costs during the quarter.
Long term AUM flows were solid at nearly $80 billion in the quarter, more than double the flows that we saw in the prior year ago period.
Ending loan balances grew $5 billion in the quarter to record levels, while ending deposits declined $5 billion due to the seasonality of tax payments.
Global banking, on slide 16, experienced strong loan growth and slightly higher investment banking fees compared to the first quarter of 2013, both of which helped drive $1.3 billion in net income and a 22% return on allocated equity.
The investment banking strength kept fees near record levels and we retained our second place ranking in net investment banking fees. Within the investment bank, underwriting fees continued the momentum from near record levels during the first quarter of ’13, and were up 53% from the second quarter of 2012.
Equity underwriting fees grew 10% relative to the first quarter of ’13, and up 86% from the comparable year ago period, due to the strong global IPO market, as well as our focus on continuing to grow capabilities within this space.
On the balance sheet, average loans increased by almost $12 billion from the first quarter, driven by growth in both corporate C&I as well as commercial real estate. As you look at that loan growth, I think it’s important to note the strong diversity in lending to our global customer base, as the U.S. represented approximately 40% of the growth, with the balance outside the U.S.
We switch to global markets, on slide 17. We earned roughly $1 billion during the quarter, on revenue of $4.2 billion, which is up significantly from the second quarter of 2012 results, but down from the first quarter of ’13. The business during the second quarter generated a 13% return on allocated equity.
Sales and trading revenue, if we back out DVA, was $3.5 billion, solidly above our 2012 results. Fixed sales and trading was down versus the second quarter of ’12, as well as the first quarter of ’13, given the rate volatility and spread widening that we saw during the last month of the quarter.
Equity sales and trading had a very strong quarter, actually the best that we’ve seen since the first quarter of 2011. Results, ex-DVA, were up 53% from the second quarter of 2012, and 4% over the first quarter of ’13, as we continued to gain market share and cash equities, improved our performance in equity derivatives, and had higher client balances in our financing area.
If you look at the balance sheet, trading asset levels did decline as we reduced risk during the end of the second quarter. Average VAR, at a 99% confidence level, was $69 million in the quarter, down from $80 million in the first quarter of last year.
On slide 18, we walk you through the results of our all other segment, which includes global principal investments, our non-U.S. consumer card business, our discretionary portfolio associated with interest rate risk management, insurance, as well as our international wealth management area.
Gains on the sale of debt securities were $452 million in the second quarter of ’13, compared to $67 million in the first quarter and $354 million in the second quarter of 2012. That, coupled with the prior quarter costs for retirement eligible compensation, lower litigation expense, higher equity investment income, and lower provision for credit losses, due primarily to the improvement in the residential mortgage portfolio, drove the significant improvement in earnings in this segment compared to both the first quarter of this year and the prior year ago period.
Before we leave this slide, two things I would note for modeling purposes as it relates to preferred dividends and taxes. The first, preferred dividends, we expect our preferred dividends to drop from $441 million this quarter to about $280 million in the third quarter, and then settle in around $260 million per quarter as we move forward. These declines are the result of the reduction of the $5.5 billion of preferred stock this quarter.
If we move to taxes, the effective tax rate for the quarter was 27%. As we look out during the balance of the year, we would expect the rate to be approximately 30% plus or minus any unusual items like the U.K. tax rate reduction.
As we’ve disclosed previously, this year’s expected U.K. corporate income tax rate is likely to be reduced by 3%, and will be enacted in the third quarter of this year. As a result, for modeling purposes, you should include a charge of approximately $1.1 billion associated with the writedown of our U.K. deferred tax assets in the third quarter of this year. But keep in mind, given where we are from a DTA disallowance position, this will not impact our Basel I or Basel III capital ratios.
And before we wrap up and take questions, I’d like to leave you with a couple of thoughts about the second quarter performance. We achieved many of the objectives that we laid out for the quarter. Revenue was solid, costs came down significantly, credit continued to improve, and our capital ratios remained strong and improved despite the change in both OCI as well as the initiation of our share repurchase program during the quarter.
The higher rate environment, to the extent it stays with us, allows us to improve our net interest income going forward, and we plan to continue to drive forward, execute on our strategy, and deliver on the earnings capability of our company.
And with that, operator, we’ll go ahead and open it up for questions.
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