Bank of America Corporation (BAC) Q2 2014 Earnings Conference Call July 16, 2014 8:30 AM ET
Lee McEntire – IR
Brian Moynihan – President and CEO
Bruce Thompson – CFO
Betsy Graseck – Morgan Stanley
Jim Mitchell – Buckingham Research
Matt O’Connor – Deutsche Bank
Glenn Schorr – ISI Research
Jonathan McDonald – Sanford Bernstein
Guy Moszkowski – Autonomous Research
Moshe Orenbuch – Credit Suisse
Steven Chubak – Nomura Securities
Paul Miller – FBR Capital Markets
Marty Mosby – Vining Sparks
Matt Burnell – Wells Fargo
Mike Mayo – CLSA
David Hilder – Drexel Hamilton
Good day, everyone, and welcome to today’s program. (Operator instructions) It is now my pleasure to turn the conference over to Mr. Lee McEntire. Please go ahead sir.
Good morning, thanks everybody on the phone as well as the webcast for joining us this morning for our second quarter results. Before I turn the call over to Brian and Bruce, let me just remind you we may make some forward-looking statements today. For further information on those, please refer to either our earnings release documents, our website or the other SEC filings.
So with that I’ll turn it over to Brian Moynihan our CEO for some opening comments before he goes to Bruce.
Thanks, Lee, and good morning everyone, and thank you for joining us. As you look at our results, you can see the storyline for this quarter is much the same as it was for last quarter. You can see that the revenue is showing stability in most of the core businesses. You can see the good core expense control, continued credit improvements, and solid business activity throughout the franchise.
You can also see obviously the litigation expense from our legacy mortgage issues continued to affect our earnings this quarter. And you can also see we’ve continued to build our strong balance sheet position and capital and liquidity. So in a minute, Bruce will take you through the details of the results.
But I thought it would be good if we spend a couple of minutes at the outset here talking about what our customer and client data is telling us about the economy and what we see in our franchise.
As we all know the economy is off to a little bit of a slow start this year, but growth has picked up recently. Most recent jobs data shows nearly 1.4 million are created in the first half of this year.
As we have strong positions, leadership positions across consumer and commercial companies in the Americas, we have a view into the key indicators of an improving economy which shows signs everywhere of improvement. Even in advance with the short-term interest rate is changing which would help our rich consumer – our deposit rich consumer and business banking segments, our consumer business had another good quarter. It performed well growing earnings 29% from last year included solid origination activities across the various products.
In addition, as we look at our underlying consumers, they have increased their spending. We can see in our data that the retail volumes on debit and credit cards were up 4% from last year’s second quarter but more importantly up 8% from the first quarter of this year showing increased momentum in spending among our card customers.
Consumers are growing card balances also, they’re borrowing a little bit more and they continue to add to their deposit balances. As you know, home sales continue to improve across the industry and we can see on our own results, as our originations and mortgages increased from first to second quarter, but importantly our purchase mortgage origination continue to grow. Our home equity originations also were up almost 30% for the quarter.
When you look at the underlying transactional activity and volume activity in our stores, 7 to 8 million visitors come in each week showing continuous strong activity. We can also see that in our online activity where 30 million online customers continue to grow their overall volumes and importantly in our mobile activity where 15.5 million mobile customers continue to increase the use of technology including depositing 10% of all the checks, retail checks in our company through their mobile phones and other devices.
The health of the consumer is also evident in our asset quality. Delinquencies continue to improve. Our consumer card loss rate ended the quarter at less than 3%. We see on the wealth management side, the consumer, the market’s growth has added to consumer wealth. We have nearly $2.5 trillion in client balances in our global wealth and investment management business including a $100 billion in the brokerage assets for their retail and preferred customer base in our consumer business.
We also see encouraging signs throughout our commercial customers. Commercial construction has improved and manufacturing activity in our clients has accelerated. The borrowing by our commercial customers remains healthy across the industry and credit quality is very strong.
Encouraging is that middle-market utilization rates are moving forward again this quarter ever so slightly. Industry sales and trading activity among our trading counterparties has been low as many of our peers have talked about in this low volatility environment.
However, our business – underlying business performed well. Tom Montag and his team had - our global markets business posted $1 billion - $1.1 billion in earnings for the quarter. Our investment banking pipeline remains strong and the back half of 2014 looks healthy.
While the economy still faces challenges, progress is being made throughout the economy but also throughout our company. We are seeing good business activity and a strengthening as we go through 2014. We are seeing improved financial health for our consumers, our customers and our corporate customers.
But the most important thing to think about is the signs of a gradually improving economy, is how our businesses is continually positioned to take advantage of the activity and deliver for you our shareholders.
With that I’ll turn it over to Bruce.
Great, thanks, Brian, and good morning everyone. Let’s start on slide 2 and work through the second quarter results. We recorded earnings of $2.3 billion or $0.19 per diluted share this quarter which included pretax litigation expense of $4 billion which equated to roughly $0.22 a share after-tax. $3.8 billion of the litigation expense is associated with the build in reserves for previously disclosed legacy mortgage related matters which also included the AIG settlement that we announced this morning.
We are very pleased to have reached the definitive agreement with AIG which resolves all outstanding RMBS litigations between the parties for a settlement amount of $650 million. This agreement is important for two primary reasons.
First, we have now resolved 95% of the unpaid balance of all RMBS as to which securities litigation has either been filed or threatened for all Bank of America related entities. It also includes AIG’s agreement to withdraw as an objector to the Bank of New York Mellon private label securities settlement referred to as the Article 77 proceeding.
Revenues this quarter, on an FTE basis were $22 billion, relative to the second quarter of 2013 revenue was down $990 million driven by lower net interest income and mortgage banking income. Relative to the first quarter of 2014, it was approximately $800 million lower as higher investment banking fees, higher mortgage banking revenue was more than offset by seasonally lower sales and trading revenue, as well as lower equity investment income.
Total non-interest expense for the quarter was $18.5 billion, but included $4 billion of litigation expense. If we back out that litigation expense and compare it to Q2 2013’s expenses, expenses improved by $1 billion or 6%, which was driven by lower LAS non-litigation expenses and to a lesser extent, our new BAC savings.
If we back out the $1 billion of retirement-eligible incentive comp from our first quarter results as well, you can see expenses declined roughly $700 million from the first quarter as a result of lower revenue-related compensation within our global markets business, lower LAS expenses ex litigation and to a lesser degree, our new BAC savings.
Provision for credit losses was $411 million with net charge-offs of $1.1 billion and a reserve release of $662 million during the quarter. Our results from the quarter also benefited from the sale of $2.1 billion in non-performing residential loans.
The income statement benefit from that sale was approximately $350 million of pre-tax or $0.02 a share after-tax and you saw roughly a $150 million of that benefit flows through other income and the balance through the recovery of net charge-offs.
And lastly, the aggregate amount of a few other items including debt securities gains, equity investment income, net DVA, as well as FAS 91 resulted in a benefit to EPS of approximately $0.04 a share.
If we move to Slide 3 and look at our balance sheet highlights, you can see the balance sheet increased $21 billion from the first quarter of 2014. Our debt securities increased as a result of valuations and increases to highly liquid securities in our primary banking subsidiaries. Our Repo match book increased as well.
If we look at ending loans, they were down $4.3 billion, primarily due to lower residential mortgages, principally within our discretionary portfolios and that also included the $2.1 billion bulk sale that I just mentioned.
If we exclude residential mortgage loans, our consumer loans rose slightly as our US card balances grew $1.3 billion and our securities-based lending with our wealth management clients increased $1.8 billion. This was partially offset by pay-downs within our home equity book.
If we move to the commercial side, commercial loans were up modestly as C&I growth was mostly offset by a few sizable loan pay-downs, as well as a focus on overall relationship returns.
Period end deposits were over $1.1 trillion and reached record levels. Our tangible common equity ratio improved 14 basis points from the first quarter of 2014 to 7.14%. Tangible book value per share was $14.24, a 3% improvement from the first quarter and it was driven by both our earnings during the quarter, as well as a $2.3 billion increase in the value of our debt securities which you saw flow through OCI.
Lastly, to further enhance our Tier-1 capital structure, during the second quarter, we received shareholder approval and amended the Series T preferred shares, which increased our Tier-1 capital by $2.9 billion, and we issued $1.5 billion in preferred stock during the quarter at a favorable rate.
On Slide 4, we show our capital ratios under Basel 3. Under the transition rules, our CET1 capital was $153.6 billion, risk weighted assets $1.28 trillion, and that resulted in a ratio of 12%. If we look at our Basel 3 regulatory capital ratios on a fully phased-in basis, we saw very strong improvements in the first quarter of 2014. Our CET1 capital improved $7 billion driven by earnings, OCI improvement, as well as well as lower threshold deductions.
The numbers in the chart reflects risk weighted assets under the standardized approach with our CET1 ratio improving from 9% to 9.5%, well above our 8.5%, 2019 proposed minimum requirement. Under the advanced approach, our CET 1 ratio improved from 9.6% at the end of the first quarter of 2014 to 9.9%. That was driven by the improvement in our capital, partially offset by an increase in risk-weighted assets.
If we turn to the supplementary leverage ratios, we estimate that at the end of the second quarter of 2014, we exceeded the updated US rules that are applicable beginning in 2018.
Our bank holding company exceeds the 5% minimum and our primary bank subsidiaries, BANA and FIA are both in excess of the 6% minimum.
If we turn to Slide 5 on funding and liquidity, our long-term debt of $257 billion was up modestly during the quarter as our debt issuances were larger than maturities during the period. As we look forward at our debt issuance during the balance of the year, we’ll continue to be opportunistic but we do expect our parent issuance to be below the $13 billion of contractual maturities in the second half of 2014.
We’ll also likely to continue to issue term debt out of our primary bank subsidiaries. Our second quarter 2014 long-term debt yields improved 12 basis points from the first quarter of 2014 2.29%. We realized significant improvements given only two years ago this yield was over 3% and our average debt balances were nearly $75 billion higher.
Our total global excess liquidity sources during the quarter increased to a record $431 billion as bank liquidity continue to grow in the second quarter and our time to required funding remained strong at 38 months.
If we turn to Slide 6, our net interest income on a reported FTE basis was $10.2 billion, consistent with the first quarter of 2014 is a less negative impact from market-related adjustments was offset by an anticipated decline in the core net interest income. Negatively impacting our reported net interest income during the quarter were market-related adjustments of $175 million and that compares to $273 million negative in the first quarter of 2014, as you all know, long-term rates declined again during the quarter.
Our net interest income, if we exclude the market-related adjustments declined as previously expected and communicated, due to seasonally lower average consumer loan balances and yields offset by an extra day of interest and all of that resulted in net interest income of $10.4 billion.
As a result of the increased liquidity in the first half of the year, as well as lower loan balances and loan yields, the net interest yield excluding market-related adjustments declined 10 basis points to 2.26%.
We continue to thoughtfully manage our OCI sensitivity and are very mindful of the liquidity and leverage rules as this quarter we invested more into shorter duration treasury securities. We continue to remain positioned to benefit if interest rates move higher, particularly from the shorter end of the curve.
And as we head into the back half of 2014, we still expect modest improvement off of the second quarter of 2014 level of net interest income, which was $10.4 billion, excluding market-related adjustments.
Non-interest expense on Slide 7 was $18.5 billion during the second quarter and once again included $4 billion of litigation expense. As we mentioned, $3.8 billion of the litigation expense relate to a build in reserves associated with previously disclosed legacy mortgage related matters including the AIG agreement. If we exclude litigation, total expenses were $14.6 billion this quarter.
If we compare those to the first quarter of 2014 and exclude retirement eligible costs that we saw during the first quarter of 2014, our expenses declined $700 million on the lower incentives related to sales and trading revenue, reduced LAS non-litigation expense and to a lesser extent New BAC savings.
Our legacy assets and servicing expenses during the quarter ex litigation were $1.4 billion and declined approximately $150 million from the first quarter of 2014. As we look forward with respect to our two expense programs, New BAC as well as our LAS expenses ex litigation, we have modified our expectations slightly.
Our New BAC expense program is ahead of schedule and we now expect to reach a quarterly level of $2 billion in expense savings in the fourth quarter of 2014 as opposed to mid 2015. This means on an annualized basis, we will have fully achieved the $8 billion target that we announced in 2011. In the second quarter of 2014, our quarterly savings rate that was achieved on New BAC was $1.8 billion plus.
Moving to our LAS expenses ex litigation, we continue to make very good progress, but our compliance with applicable mortgage programs as well as governance guidelines may delay the expected timing of achieving our $1.1 billion goal by one quarter.
If we turn to asset quality on Slide 8, you can see credit quality once again improved on all fronts. Net charge-offs declined $315 million from the first quarter of 2014 to $1.1 billion or a 48 basis points net loss ratio.
As I mentioned earlier, this quarter did include a $2.1 billion sales of bulk non-performing loans, which included recoveries of $185 million on previously recorded net charge-offs. If we exclude the effect of the bulk sale net charge-offs, they’ve declined a $130 million or 9% and the net loss ratio would have been at 56 basis points. These are decade level loans.
Delinquencies, a leading indicator of net charge-offs also showed improvement during the second quarter. Provision expense during the quarter was $411 and we released $662 million of reserves. We would expect net charge-offs going forward to continue to show modest improvement from the second quarter of 2014 levels of $1.3 billion, which excluded the recoveries that we received on the non-performing loan sales. We would also expect reserve releases to decline modestly through the balance of 2014.
Let’s walk through the business segment results now starting on Slide 9 with consumer and business banking. We continue to make solid progress on the strategy in this business through deepening relationships and reducing our costs by optimizing the delivery network. We are simplifying the product set as we reduce the number of offers, offerings and focus the smaller product sets on customer feedback and offer greater rewards to customers who bring us more of their relationships.
Some of the more significant operational activity during the quarter included the rollout of an advanced platform for mobile banking that had added functionality, rolling out the safe balance checking account, as well as an enhanced preferred rewards program that we launched after a successful pilot program. We are pleased with the results again this quarter as our earnings of $1.8 billion grew $29% from the second quarter of 2013 and were up 7% from the first quarter of 2014.
This business generated a 24% return on allocated capital during the quarter. Our revenue was relatively stable across the periods as lower net interest income was partially offset by higher service charges. Our expenses are down 4% from the second quarter of 2013 and lower operating, litigation and personnel costs. Our network delivery optimization benefit continued as we reduced another 72 banking centers through both sales as well as consolidations.
Our credit quality remains strong as net charge-offs decline versus both periods. Our U.S. credit card business exited the quarter with less than a 3% loss rate in June. Second quarter provision expense was $534 million, our net charge-offs improved $313 million from the second quarter of 2013 and $36 million from the first quarter of 2014.
We released $120 million more in reserves this quarter than the second quarter of 2013 and $242 million more than the first quarter of 2014. From a customer activity perspective this quarter, we saw continued growth in our mobile banking customers which reached 15.5 million customers and our customer deposit transactions using mobile devices represented 10% of all transactions.
Our average deposits of $544 billion are up organically almost $11 billion or 2% compared to the first quarter of 2014 and up 5% or nearly $25 billion compared to the second quarter of 2013 and we did that as our rates paid on our deposits reached a new low of 6 basis points.
Our brokerage assets surpassed $105 billion and are up 26% year-over-year based on both improved market valuations as well as customer flows. Our card issuance remained strong at 1.1 million new accounts in the second quarter of 2014 with approximately two-thirds of those cards going to existing customers.
We saw growth in ending U.S. credit card balances this period with ending balances up $1.3 billion relative to the first quarter of 2014 and our risk-adjusted margin remains strong at approximately 9%. If you move to consumer real estate services, the loss in the quarter was driven by $3.8 billion of litigation expense.
Overall, we saw higher originations, improved mortgage banking revenues, and lower cost in both the fulfillment as well as the servicing sides of the business. Let’s focus first on the reported sub-segments of home loans where we record the origination of consumer real estates.
Our home loans saw better leverage versus the first quarter of 2014 as both revenues and expenses improved. Our first mortgage retail origination were $11.1 billion and were up 25% from the first quarter of 2015 leading to higher core production revenues. As Brian mentioned, our mix of originations continued to shift to purchase as we are now at 47% purchased versus 17% in the year ago quarter.
At the end of the quarter, our origination pipeline was up 15% from the first quarter of 2014, but our applications per day are slowing a bit. Our home equity originations were $2.6 billion and increased 31% from the first quarter of 2014. We continued to reduce production staffing levels and the savings from several quarters of these reductions are beginning to show in our expense levels.
If we move to the legacy assets and servicing sub-segment, the driver here was aforementioned litigation costs. From a cost of servicing perspective, our LAS expenses ex litigation did declined $141 million to $1.4 billion and our number of 60 plus day delinquent loans dropped 14,000 units to 263,000 units or down 5% from the end of the first quarter of 2014.
The primary revenue component in our LAS sub-segment servicing fees declined $40 million versus the first quarter as the size of our servicing portfolios declined. This was offset by a better net hedge performance on our MSRs. Also during the quarter, we did benefit from lower rep and warrant provisions which was $87 million or down nearly $100 million from the first quarter of 2014.
If we turn to Slide 11, global wealth and investment management, this business turned in another record revenue quarter, our pre-tax margins remained strong north of 25% for the sixth consecutive quarter. Our revenue of $4.6 billion was up 2% from the second quarter of 2013 and 1% over the first quarter of 2014.
Record asset management fees offset the softness in transactional activity. Net income, $724 million was slightly lower than both comparative periods, driven by increased expenses. Our expense levels versus the second quarter of 2013 reflect higher revenue-related incentive comps, other volume-related costs, as well as continued investments in technology and other areas that support the growth that we are seeing within the business.
Relative to the first quarter of 2014, expenses were driven by higher revenue-related costs, litigation-related expenses as well as marketing. Our return on allocated capital during the quarter was 24%. The momentum we are seeing in flows continued and was quite strong during the quarter.
Client balances were up $72 billion from the end of the first quarter of 2014 to a record $2.5 trillion. Long-term AUM flows were nearly $12 billion for the quarter marking the fifth straight year of positive quarterly AUM flows. Our ending client loan balances were up $3.9 billion to a record $123 billion, which is up 3% from the first quarter of 2014 as we saw growth in both our securities-based lending as well as our residential mortgage lending.
From a referral perspective, we continued to see coordinated efforts across wealth management and the banking groups as our referrals resulted in the funding of more than 250 institutional retirement plans worth more than 2.4 billion assets this quarter and that compares to a 156 wins in the year ago quarter of 600 million assets.
If we turn to Slide 12, our global banking earnings for the quarter were $1.4 billion, up 4% from the second quarter of 2013 and up 9% over the first quarter of 2014. Our return on allocated capital was very strong at 18%.
Compared to the second quarter of 2013, our revenue showed modest improvement while expenses increased and credit cost declined. Within the revenue category, our investment banking fees, company-wide this quarter were $1.6 billion, up 5% from the second quarter of 2013 and up 6% on a linked quarter basis. We maintained a solid leadership position in investment banking fees and we had particularly strong equity underwriting results during the quarter.
Our provision was $132 million during the quarter and included a $156 million reserve build. Our provision costs were favorable to both comparative periods as we added less reserves in the first quarter of 2014 and had less charge-offs compared to the second quarter of 2013.
Expenses increased $50 million versus the second quarter of 2013 on higher litigation, but improved $129 million from the first quarter of 2014 on lower personnel and back-office support costs.
If we look at the balance sheet, average loans were $271 billion during the quarter, up 6% compared to the second quarter of 2013, but flattish compared to the first quarter of 2014. Our loan balances relative to the first quarter of 2014 bear – I think several comments, but I’d like to make the first is, we saw sizable pay-downs during the quarter as our customers accessed the capital markets. We had approximately $2 billion of such pay-downs where our customers chose access to markets and refinanced existing bank loans.
Within commercial real estate, we continued to optimize the mix with several small portfolio sales that took those balances down, little over $2 billion. We are being sensitive with respect to pricing of commercial loans as we are not going to chase loans at the expense of overall client relationship profitability goals.
And lastly within the global banking segment, deposit flows remained solid and were stronger at the end of the quarter.
If we move to global markets on Slide 13, we earned $1.1 billion in the second quarter of 2014, that’s up 14% from the year ago period and down seasonally 16% from the seasonally strong period of the first quarter. Net DVAs during the quarter was a gain of $69 million versus gains of $49 million in the second quarter of 2013 and a $112 million in the first quarter of 2014.
Despite the slowdown in FICC across the industry group, we were pleased with the results this quarter. Our revenue was up 9% from the second quarter of 2013, but down 9% from the seasonally high first quarter of 2014. Our second quarter of 2014 revenue did include an equity gain of roughly $240 million on the modernization of an equity investment. That is not reflected as part of our sales and trading revenues. Our sales and trading revenue net of DVA was $3.4 billion which was 1% lower than the second quarter of 2013 and 17% lower than the first quarter of 2014. Our FICC sales and trading revenue during the quarter increased 5% compared to the second quarter of 2013 and was down 20% from the seasonally higher first quarter of 2014 levels.
Driving the year-over-year improvement within fixed were results in our mortgage business, our munis business, as trading conditions and our performance improved in both areas. Those improvements were partially offset by weaker financial performance in foreign exchange as well as commodities.
On the equity sales and trading side, we were down 14% from the second quarter of 2013 and 11% from the first quarter of 2014 as lower market volatility depressed overall secondary market client activity. Expenses were up from the second quarter of 2013 on higher technology and staff support investments and to a lesser degree incentives, but down from the first quarter of 2014 in line with the seasonal revenue decline that we saw.
Trading-related assets on average increased $23 billion to $460 billion during the quarter and our return on allocated capital was 13% during the second quarter.
On Slide 14, we show all other; revenue was down $463 million from the first quarter of 2014 and lower equity investment gains of $618 million which were partially offset by lower negative market-related adjustments to net interest income during the quarter.
Our second quarter 2014 expense and all other is down $1.3 billion from the first quarter as it included retirement eligible incentive costs and some litigation expense. The second quarter of 2014 provision benefit of $246 million was $111 better than the first quarter of 2014 and $67 million better than the second quarter of 2013.
Net charge-offs of $11 million improved $195 million from the first quarter of 2014 driven by the recoveries that I had mentioned associated with our bulk NPL sales.
During the quarter, our effective tax rate was relatively low, primarily as a result of the impact of tax preference items on a lower earnings base. For the back half of 2014, we would expect to see an effective tax rate of approximately 31% ex any unusual items.
I am going to wrap up before we take questions with a couple closing comments. We feel like we made very strong progress during the quarter. We saw good business activity across the customer base. We experienced year-over-year revenue growth in our global banking, global markets and global wealth management businesses.
Our consumer business profitability grew 29% from last year and in the mortgage business we are taking cost out of the fulfillment side as well as the cost to service our delinquent loans. We reported $0.19 of earnings and absorbed cost allowing us to resolve all outstanding RMBS issues with AIG and build substantial reserves for our remaining legacy mortgage issues.
We did this while adding to our already strong Basel 3 capital ratios and improving our liquidity measures to record levels and our asset quality improved to decade low loss ratios. And with that, we’ll go ahead and open it up for questions.
Earnings Call Part 2: