Bank of America Corporation's Management Presents at the Morgan Stanley Financials Conference (Transcript)
Start Time: 07:25
End Time: 07:57
Bank of America Corporation (BAC)
Company Conference Presentation
June 11, 2013, 07:25 AM ET
Executives
Bruce R. Thompson - CFO
Analysts
Betsy Graseck - Morgan Stanley
Presentation
Betsy Graseck - Morgan Stanley
First to come up, I do want to use the polling device here to ask a couple of questions and get your views on a couple of thoughts regarding BofA and help set the stage for our conversation.
So the first poll question here, what would drive you to add to your Bank of America position; a, housing improvement accelerates; b, a more aggressive return of capital; c, execution on expense reductions flowing to the bottom line; or d, stronger loan growth? Take a minute – well, take 10 seconds actually and think about what your answer would be there.
Okay. And the answer is c, expense reductions. Well, this is great because that is my first line of questions for Bruce, so appreciate that, 51%. And then interestingly loan growth comes in ahead of housing and an 8% is on capital return. So I think that is a little bit of a difference SKU to maybe what people had been anticipating, at least what I have been anticipating. I thought capital would have gotten a bigger vote there.
All right, second question. How much in expense cuts do you think BofA can achieve over the next three years? We're talking about the SG&A line, are you looking for in your model, 0 billion to 5 billion incremental; 5 billion to 10 billion; 10 billion to 15 billion; or d, 15 billion plus? And this is tying into that first question as well.
And the answer is this group is looking for 5 billion to 10 billion of incremental expense cuts dropping to the bottom line at BofA; super.
Well, I'd like to ask Bruce to come up as we introduce him. I'm very pleased to introduce Bruce Thompson, CFO of Bank of America. Bruce has been with BofA for 17 years and has held a variety of senior roles in global capital markets. He's also served as Chief Risk Officer before becoming CFO a couple of years ago.
Bruce and team have been reducing expenses and putting legacy issues behind them, as you know, with key settlements like MBIA and Fannie Mae. And at the same time they've been able to dramatically improve the Basel III capital ratio 100 basis points above the [SS fee] minimums that were outlined a while back, and are on track to buyback 5 billion of stock over the next year.
So we're going to have a fireside chat this morning, but first I wanted to ask Bruce if he could help us here with just setting the stage and giving us his key thoughts on BofA.
Bruce R. Thompson
Sure. Thank you, Betsy Graseck. Thanks for hosting us this morning. I'm going to spend just a few minutes talking about as we came into '13 and as we've worked through 2013, three overall fields that we're looking at as a company. The first is stability both from a revenue and a capital perspective. The second are the differentiating levers that we believe that we have that are unique within the industry; and then third, the momentum that we're seeing within the individual businesses.
Let me start just first with stability. As we came into the year, there were questions in and around what is a core revenue number with which we can start to push off of? And as we look at core revenues and came in '13, we looked at $22.5 billion generally per quarter. Obviously the first quarter is seasonally strong. We did better than that and we think on average, that $22.5 billion is a good number to grow from.
As we look at that, roughly 40% or $10.5 billion of net interest income a quarter is a good number that we're looking to build from. And as we look forward, particularly in the third and fourth quarters of this year with the size of the debt footprint coming down pre any impacts of FAS91 and hedge ineffectiveness, we see the opportunity to grow that and to move it forward.
You referenced capital. At the end of the first quarter, we were a little over 9.5% Basel III capital on a fully phased-in basis. Given where we are from a DTA position as we move forward, our pre-tax is pretty close to after-tax. So between that as well as opportunities on the balance sheet, we think we'll continue to drive that forward.
And then the last point I would make on stability is just overall asset quality as we work through 2013 and I think an overall economic environment that's probably a little bit less robust than we would have underwritten to credit quality continues to outperform, so we feel very good about that as we work through 2013.
The questions that you asked as we look at differentiating levers as we work forward, I think clearly the expense opportunity is one that we started on in 2011 with our new BAC effort. And as we've talked about in the guidance remains the same, we were about $900 million of benefit per quarter. When we left 2012, we think that number on a quarterly basis will be 1.5 billion at the end of 2013, and we'll get substantially the rest of the $2 billion of quarterly savings by the end of 2014.
If we move the legacy assets in servicing, we obviously peaked during the fourth quarter of 2012 at $3.1 billion in the fourth quarter of 2012. We've been pretty consistent saying we'll get at least $1 billion of that out in 2013, so we'll leave 2013 at less than 2.1 billion a quarter of expense. As we work through '14 we think that number will be less than 1.1 billion when we leave 2014. And ultimately when we leave 2015 that number needs to be $0.5 billion or less per quarter.
I think as you look at what we were able to work through during the first quarter that we feel very good about the progress we're making within legacy assets and servicing. Over and above that, two other things; I mentioned a debt footprint. During the last three quarters of 2013, about $20 billion of debt maturities; 2014 upwards of $40 billion. While there will be a portion of that refinanced, you should assume a significant amount of that will be repaid either with existing cash or money that moves up from the banks to the parent company.
And then lastly as we look at the levers, we obviously announced the redemption of the preferred stock that was part of our CCAR submission. That will happen during the second quarter of this year or it has happened given that we're now in June; about $5.5 billion that's been redeemed, ongoing savings of about $450 million and as we've said will take about $75 million impact this quarter from that redemption.
If we move into the businesses and look at we've seen within the businesses, if we look at deposits first quarter '12 to first quarter '13 on the consumer side, deposits are up about 7% and we continue to be aggressive as we push down the cost of those deposits. As we look at the credit card business, about 900,000 cards went out during the first quarter, which is the largest number of cards that we've seen go out since 2008. And we work through this quarter, we are starting to see some stabilization of outstanding credit card balances.
Within mortgage Q1 '12 to Q1 '13, 57% growth. We obviously took market share down when we got out of the corresponding business. We've been building that backup and would expect to be in the 5% area as we exit the second quarter and we look to continue to grow from that.
Within the Wealth Management business, the first quarter was obviously a very strong one for us in that business. If you look at revenues, long-term asset flows, outstanding loans, as well as pre-tax margin at 26%, record quarters across the board post merger in the business particularly as the markets moved up that we continue to feel very good about.
If we flip to a moment to the institutional businesses, investing banking fees, we were number two just behind the number one player in investment banking fees globally during the first quarter of '13. We've picked up market share there over the course of the last three quarters, and continue to feel very good about that business.
You've seen on the backs of those banking fees our loan growth within the institutional business has been very good. We're about 8% Q3 to Q4, about 3% in the first quarter this year and we are continuing to see commercial loans press forward.
On the sales and trading business, as we look at the equities business, first quarter this year that we were one of the few if not the only firm that from an equities perspective was up Q1 '13 relative to Q1 '12, and some of the changes that we've made in that business we continue to see improvements there. And as we look at that FIC business and continue to believe we're in about a number two share there, and feel very good about the client activity there.
So, as we continue as we came into '13 and as we work through 2013 between the stability, the levers as well as the momentum in the businesses, we feel like we're making very good progress.
Betsy Graseck - Morgan Stanley
Thanks for such a great update on where you are Q-to-date. So I think from the polls what we learned too is that and I'm sure you all know, expenses are top of mind with people as well as interest rates. Maybe we can hit those two topics before we open it up to some questions from the audience.
Bruce R. Thompson
Sure.
Betsy Graseck - Morgan Stanley
So on expenses, you outlined where you are planning to go with the reduction in LAS expenses as well as New BAC. The question I keep on getting from investors is what about the hedge top line. So could you outline a little bit how much revenue these expenses are facing both in LAS and in the New BAC?
Bruce R. Thompson
Sure. I think the important thing when – and glad to see you get the question because I get it often as well. Particularly when you look at the expenses, you have to put these expenses and the things that we're working through into two buckets. The first is when you look at legacy assets and servicing, we basically have put a box around these bucket of loans of products that we no longer offer or delinquent. The sole purpose of legacy assets and servicing is for those people that qualify for a modification to get the loans modified and for those that don't is to work those through the foreclosure process, short sale, deed in lieu, whatever the alternative is. So that area is not one that's focused on revenue. There is some servicing revenues that come off of that that in a scheme of things are very minor. So when you look at the most significant expense initiative that we have going on, it's within a business where quite frankly we're not focused on the revenue stream, we're focused at this point which at the end of the first quarter is getting $2.6 billion of expense out of the company. And as you look at how that's going to come out, the biggest piece that we need to do to get the expense out is to get out the number of 60-plus day delinquent loans. And as we talked about during the first quarter, we made a lot of progress in getting that number of delinquent loans down. And as we look out at the end of 2013, we continue to believe that we'll be below 400,000 delinquent loans at the end of '13. And as we drive through '14, we'll be at a normalized level at the end of '14. So that's the legacy assets and servicing piece, clearly the most significant opportunity of the two. If you move to the New BAC initiatives that we're doing, at this point the remaining work to be done within New BAC does not touch client (inaudible) people at all. So the remaining work that needs to be done within New BAC continues to be whether it'd be back office, technology, support areas and other areas within the consumer business that need to come down. There's still some branch rationalization that needs to come out that will work through that. And then I would say overall, more fixed costs back office stuff within the institutional business. So as you look at that, there should not be any revenue degradation because we're not touching the people that are responsible for originating revenues. And if you look and I think across the company and you look at the expense initiatives, we're actually adding to the front office people within the company. That being said, we feel good about the expense guidance we've given. So if you look at mortgage loan officers, if you look at fulfillment on the mortgage business as you look at corporate bankers, as you look at consumer bankers within the branches that are responsible for cross selling and looking to offer other products within the branches, we're adding in those areas. So if we do this the way that we believe that we will, we should start to see revenues push forward and not go backward with the expense initiatives.
Betsy Graseck - Morgan Stanley
Okay. So just two quick follow-ups on that. On the servicing side, you said that the revenue impact is really [throughout] the grand scheme of things, but is it possible for you to put a little bit of a number on that?
Bruce R. Thompson
We said I think the biggest piece to look at is what we term [project Mosaic] which will be the third party sales that we said that we were going to do. And between the fourth quarter of '12 and the fourth quarter of '13, we said it's about $200 million a quarter.
Betsy Graseck - Morgan Stanley
Okay. And that's in the run rate right now?
Bruce R. Thompson
A good portion of that would have been in the first quarter run rate. The rest of it would come out in the second quarter.
Betsy Graseck - Morgan Stanley
Okay. And then the LAS expenses, $1 billion decline in the run rate is what you're expecting this year. You already got half of that in first quarter. Are we going to see a significant step down? I mean you have been selling portfolios, so I'm interested in understanding why should we expect a significant step down in that run rate 2Q, 3Q and 4Q?
Bruce R. Thompson
Well, I think as I said obviously we feel very good in the first quarter, we got through 0.5 billion of the 1 billion. As you look at it, if you go back, you started to see the number of 60-plus day delinquent loans come down dramatically in the third quarter of last year and we've always said there's kind of a one to two quarter lag. So a lot of what we would have seen in the first quarter was the work that was wrapped up in the third and fourth quarters of last year. The other thing I would say is as we look out, a lot of the servicing sales of the 60-plus day delinquent loans are closing as we work through the second quarter. So I think as we look through the year, you're probably going to see the next materials step down more in the third quarter of this year.
Betsy Graseck - Morgan Stanley
Okay, great. And then as people are thinking about what the core run rate should be in expenses, how do you answer that question?
Bruce R. Thompson
What I would say is if you go to our earnings chart, we've got a chart that has four different buckets and I would go through the different buckets. The core of the first one that if I recall was in red. We've said there was about $800 million of elevated compensation expense that was in the first quarter relative to what we'd expect based on the quarter that the sales and trading business had. So you've got 800 of that and you've got the New BAC that will flow through that line. The employee retirement and eligible compensation expense is a once a year thing, so that obviously goes away. The LAS bucket that was 2.6, as I said, we'll get that below 2.1 this quarter. And then obviously the litigation expense we'd expect to be significantly less as we work through the year relative to what we saw during the first quarter.
Betsy Graseck - Morgan Stanley
Sure, okay. Just turning a little bit to rising rates, we've obviously had a significant amount of rate volatility so far this quarter, I think today it was 10 years back up to 225. A couple of questions here. One is on how you're managing through the impact on AOCI? And in your 10-Q you highlight that if the long end of the curve went up 100 basis points, you get a pre-tax benefit and NII is about 1.6 billion, maybe 1 billion after-tax. And if it was parallel shift, right, and continue short parallel shift, maybe it's 3.7 billion. How long will it take to earn through that AOCI short? I mean you gave us the earnings, the 1.6 and the 3.7 on the 100 basis point with the long end and then the parallel shift, but how long does it take you to earn through that?
Bruce R. Thompson
Sure. I think the first thing I'd say, Betsy, is we look at managing interest rate risk, we look at and manage the risk through the three different buckets that we think can affect capital. The first is the MSR, the second is the OTI risk and then the third which offsets is net interest income. So we manage those three things in the aggregate, but to directly answer your question in the context of a parallel shift in interest rates, I think it's probably 2.5 to 3 years to earn back any impact in OTI purely out of net interest income. Obviously, if you look at that OTI in any one quarter given that we accrete capital on a pre-tax basis that I referenced, clearly we'd expect in any quarter to more than earn that. But as it relates to just the tradeoff between NII and OTI, we think about it in the context of 2.3 to 3 years.
Betsy Graseck - Morgan Stanley
And what about the long end of the curve moving up, what if you had an environment where the 10-year went up 100 bips but then we didn't have a frontend move?
Bruce R. Thompson
It'd be the difference between 3.7 and 1.7…
Betsy Graseck - Morgan Stanley
Okay.
Bruce R. Thompson
Generally, they start getting into different permutations of the curve but obviously it'd be about twice as long.
Betsy Graseck - Morgan Stanley
Okay. And I guess the thought then is as it relates to your capital ratio if you had the parallel shift, you'd had a capital ratio impact but order of magnitude relatively…?
Bruce R. Thompson
You're looking at in the context of 3.7 billion going one way or you're in the context of probably 50 to 60 basis points just related to the NII outside of anything that we had from an earnings perspective.
Betsy Graseck - Morgan Stanley
Right. And given your capital ratio strength right now at 9.5, it feels like you could absorb that if that…
Bruce R. Thompson
More than absorb that…
Betsy Graseck - Morgan Stanley
Right, got it. Okay, super. Well, I'll turn to the audience and see if there is any questions from the room that people want us to move towards, otherwise I can keep going up here.
Okay, great. So I'm just going to follow-up on a couple of other questions as it relates to rates. One is on the impact on the mortgage business. So obviously the interest rates have backed up significantly. You've got 30-year fixed rates [before] handle. You started to see some market tier shift towards [arms] creeping from 2% to 6%, but it looks like we're beginning to have an impact on housing. Maybe if you could give us a sense as to what you've seen in your mortgage business, how has this 4% handle on Fannie, Freddie loans impacted either demand for purchase – demand for refi and could you give us a sense as to what we should be thinking about your mortgage revenues as we go through the quarter and into next?
Bruce R. Thompson
I think it's a little bit tough to talk about 4% mortgage rates given that this upward movement rate has just happened over the last two weeks. I would say the first thing that you typically see which we have seen when rates go up like this is everyone that has a lot or is in the mortgage process all of a sudden works very hard to get their mortgage process through, so they're able to benefit from the improved rates. So I think as we work through the quarter, clearly those people that were in the queue working through, there's been a lot of focus with respect to them getting through the process, which we'd seen and we've seen that during the second quarter. I think longer term, as we look at this, that there's two sides to the equation. There's the what is the perceived attractiveness that people feel within housing as they look at new purchased housing versus the cost of it from a rate perspective. So I would say as it relates to just the straight refi, obviously to the extent rates are moving up you're going to have a negative effect on what you're able to do from the straight refi programs. We haven't seen much of that yet just given how new this increasing rate environment is. Then secondly and I think there was an interesting article in the Times over the weekend that there is this view and I think we continue to see is that people are starting to feel much better about housing and the fact that they may pay 50 or 100 basis points, it may affect a little bit but the ability of what they're able to afford. But right now there's clearly a lot of interest in people purchasing houses.
Betsy Graseck - Morgan Stanley
As (inaudible) we've seen is the gain on sale come down a little bit obviously the last quarter or the quarter before, but even the last couple of weeks we've seen a significant decline right on the gain on sale margins. So the question essentially is should we be anticipating that as you're increasing share and mortgage origination, should we expect that you'll have either less increase or flattish mortgage revenues?
Bruce R. Thompson
Yeah, I think you have to bifurcate the two that as we look at the share gains and the progress that we're making, we think that share gain is coming and getting what we believe is our fair share back. We obviously have roughly a 12% market share in deposits, that mortgage market share got down as low as – excuse me, the high three. And so as we move that forward up towards the 5%, I referenced, we think that's a lot more about getting back and becoming who we should be and where the gain on sale margins are and what we're able to see there is more a function of where the overall market is pricing not anything individually we're doing as a company.
Betsy Graseck - Morgan Stanley
The other question is on your relationships with the GSCs, obviously you've settled with Fannie earlier. But if I have it correct you're still working primarily if not predominately or entirely with Freddie. So the question is can you get to that market share goal that you have with mortgage originations, working with just one GSC?
Bruce R. Thompson
I'd say as we look out over the course of the last quarters as we've built the share, it's done just with respect to dealing with the one GSC and (inaudible) to look out where we've focused the mortgage business. A lot more of the focus that we have is originating mortgages for people that do a variety of products with us that are core consumers that were trying to do a lot of different things with a number of which are looking for nonconforming, not conforming mortgages. So the ability to grow that share whether it'd be in our preferred space or within the overall Wealth Management business doesn't really have much to do with moving out to GSC because it's going to end up on our balance sheet.
Question-and-Answer Session
Betsy Graseck - Morgan Stanley
All right, okay. Okay, a question from the room over here will be…
Unidentified Analyst
Bruce, in regards to reserve releases, I was wondering if you have any update and thoughts of that going forward, and also in relation to the new potential rules for reserving that will be coming forward, if that's factored into your thinking of forward releases of reserves and in simply what are your thoughts on the potential new rule?
Bruce R. Thompson
I think as it relates let me start with the second one on the potential new rule, there's obviously still a lot of discussion and a lot of dialogue around that. And while we clearly have to acknowledge that that's out there, at the same time as we look at overall reserving we need to operate in an environment that we are in today and with the rules that we're in today. So that's what we're doing. I think as you look back, the guidance we had given back several quarters ago was a provision number of 1.8 to 2.2 with charge-offs coming down and reserve releases slowing. What I would say is that as you saw in the first quarter, we continue to have very good improvement in that charge-offs and I think over and above the improvement in charge-offs, some of the delinquency in new early stage delinquency continue to improve. So as we look through the quarter, we obviously have another month but I think we continue to be very positive with what we're seeing not only on charge-offs but overall credit quality of the outlook for the next couple of quarters.
Betsy Graseck - Morgan Stanley
Okay. Yep, a follow-up over here.
Unidentified Analyst
Bruce, how are you?
Bruce R. Thompson
Hi, good morning.
Unidentified Analyst
So we talked about expense targets, right, and we've heard the question on revenue but maybe if you boil it down to an efficiency ratio, have you considered maybe discussing efficiency ratio target say in the next 18 to 24 months and ROTE targets as well?
Bruce R. Thompson
Sure. Let me start, as you look at where we [said] is it relates to returns on tangible common, obviously we're not at this point if you look at the first quarter where we were in 2012, we were at returns that clearly are not where they need to be. And ultimately those returns in the way that we're running the business as we look out over a two to three-year horizon is that those returns need to be in the low teens type area and that's what we continue to work for. And as we look at the model as we go out into 2015 and beyond, that's where we're pressing ourselves to get to as we move forward. As it relates to efficiency ratio and I think the question is as you get to the out years, we start looking at efficiency ratio, part of the question which you highlighted this morning was what's the rate environment that you're in? But as we look out and as we look at getting through legacy assets and servicing being the last big piece of the expense reductions, clearly that efficiency ratio needs to get in the mid to high 50s as we get through the legacy assets and servicing. And I think if you look at that type of efficiency ratio, you tend to get to the types of returns that you'd expect to start on tangible common equity.
Betsy Graseck - Morgan Stanley
So you thinking to get to the mid to high 50s – bring your expense ratio down to the mid to high 50s without a rate hike?
Bruce R. Thompson
You're probably looking at more high 50s without rate hike and then the question is how much rate do you have to improve from there.
Betsy Graseck - Morgan Stanley
Right, okay. A question on capital. You started with this year's CCAR to be able to buy back some stock, 5 billion that you've indicated [plus] 5.5 billion as well. Can you just give us a sense as to what you've learned in last – this past year's CCAR and what do you think you need to do to position yourself, to position BofA for an even larger buyback request?
Bruce R. Thompson
I think the first thing that we've seen that the industry has seen as you go through the CCAR process that there's clearly a quantitative aspect to it and there's also a qualitative aspect to it and you have to do well on both of those. And so we continue to dedicate an enormous amount of resources to make sure that we do that well. I think the second thing that we've learned is that as you go through the process, you need to try to build in as much predictability to your process as you can so that when you get through the process, you understand and have a very good sense as to what your own stress testing results produce. So one of the things that we do as a company to try to make that as predictable as possible is we go through the stress testing process while it's not required on a quarterly basis and one of the things that we do every quarter is we continue to stress against one of our own scenarios that we don't change with the exception of the starting point in the balance sheet as well as the case that the Fed ran as part of the prior year's CCAR process. So as we do that and as we test that just as a matter of – we think is running the company while we do that on a quarterly basis and the add-on benefit to that is that as you go forward, you hopefully bring more predictability to that process. The other thing I would say is as we look at capital and look at capital returns, we look at really the three legs that you need to address and feel comfortable with your capital policy. The first is where are you with the market risk amendment being put in place from a CCAR Basel one-and-a-half process and obviously with capital distributions, there is a – the Fed came out and posted roughly 6%. There's the drive path and how are you doing on Basel III, as we mentioned earlier north of 9.5%. We feel very good about where we are in Basel III. And for us the key driver does relate to how we're going to be able to return capital this quarter, and so a lot of the questions that we've gone through between the rate environment and expenses that that is going to be in our minds the most determinant factors to capital returns is our ability to continue and to drive core earnings and to improve where we're operating from today.
Betsy Graseck - Morgan Stanley
So as you prove out that sustainability and predictability of earnings, that's one of the big legs up in the apps for increased buyback, right?
Bruce R. Thompson
Absolutely. And I think the other thing that's important and when you all cut up the expenses once again, that as we work through and prove out the expenses, I think the earnings power of our company becomes a lot more clear and there's a lot less variability as we drive those expense reductions, because our impression and I don't want to speak for anyone else is that as those expenses come down, people do tend to view that as permanent improvement.
Betsy Graseck - Morgan Stanley
And so the follow-up question is just you have a high capital ratio relative to what the minimums are there required, even if you want to be a little bit more capitalized similar to some of these other peers given the capital accretion, you're going to be building that up over the next year or two years. So should we be anticipating that the app for capital return is more step function in nature given the capital ratio you have and given the expenses coming down, or do you think that it's more of a gradual slow build up over time?
Bruce R. Thompson
I expect that the – I'll come back to that – if you look at the three different legs, it's an earnings leg which is going to be determinant, so it's our job to drive that as hard as possible so that what we look at from a capital distribution perspective can move up consistent with earnings, and that's what we're focused on. But I think the other thing I'd say just as you look at that, we're at a point with the balance sheet and between the impact of home prices and what's running off that we do believe that we're able to operate the balance sheet from a risk-weighted asset perspective, generally in the ranges that we are now which comes back to your question about earnings.
Betsy Graseck - Morgan Stanley
Super. Well, thank you very much, Bruce. That wraps up our session this morning. Join me in thanking Bruce for joining us today.
