Fitch: Litigation Expenses Hide Improvements in Bank of America's Operations

CHICAGO--()--Bank of America Corporation's (BAC) stated second quarter 2014 (2Q'14) earnings of $2.3 billion were impacted by $4 billion of litigation charges, after having absorbed $6 billion of litigation charges in the sequential quarter. This latest charge masked what Fitch Ratings believes is some of the progress BAC has made in streamlining its franchise and improving its businesses. As such, notwithstanding the continued--and significant--litigation costs, Fitch views the quarter's results as incrementally positive.

Fitch calculated pre-tax profits, which excluded CVA/DVA adjustments and various other gains/losses and charges amounted to $2.9 billion in 2Q'14, which equated to a 0.54% pre-tax adjusted return on assets, which is modestly better than the 0.46% pre-tax adjusted return on assets including both of last quarter's charges. For comparison purposes, excluding the $4 billion of legal charges this quarter would yield a 1.28% adjusted return on assets, which Fitch views as good. Should BAC begin at some point to experience significantly lower litigation costs, the earnings power of the company's strong franchises will be more evident.

Fitch continues to believe that over a longer period of time as BAC eventually incurs fewer litigation costs and continues to execute on its efficiency initiatives, it's possible for the company's earnings to approach peer levels and to also come closer to Fitch's estimate of BAC's long-term cost of equity assumption.

Drivers of the company's earnings this quarter included lower provisioning in the Consumer & Business Banking (CBB) segment, continued cost reductions from Legacy Asset Servicing (LAS) in the Consumer Real Estate Services (CRES) segment, lower representation and warranty expense in CRES, continued strength in Global Wealth and Investment Management (GWIM) amid higher markets, somewhat stable results in Global Banking (GB), and comparatively satisfactory results in Global Markets (GM).

GM has been a source of weakness for many banks amid low volatility and slowing client volumes. BAC was not immune to these market conditions relative to the sequential quarter in both Fixed Income Currency & Commodities (FICC) and in the equities trading business. FICC revenue, however, modestly increased relative to the year-ago quarter as better performance in mortgage trading and municipals was partially offset by a decline in foreign exchange (FX) trading and in providing derivatives for commodities exposure.

Despite continuing to have elevated overall expenses, management continues to make efforts to drive down costs. In 2Q'14, this included further headcount reductions primarily in the LAS group, continued rationalization of the company's branches which declined by another 72 from the sequential quarter, and an acceleration of quarterly cost savings of $2 billion from New BAC initiatives which the company now expects to be fully realized by 4Q'14. These expense savings are critical, as they remain one of the key levers management can pull to improve future earnings performance.

BAC's overall loan portfolio declined relative to the sequential quarter due to a mix of the continued resolution of troubled assets and some loan sales. BAC's overall asset quality metrics continue to improve and Fitch expects this to continue over a near-term time horizon. However, industrywide, Fitch continues to believe that credit quality is near a cyclical trough and that over an intermediate to longer-term time horizon, there should be some reversion in asset quality measures, particularly in commercial lending.

BAC's liquidity position remains sound given its strong deposit franchise and its increase in Global Excess Liquidity Sources, which now amount to $431 billion.

BAC's capital position also improved. BAC's Basel III Tier 1 common equity ratio under the standardized approach (BAC's binding constraint under Basel III) increased to 9.5% in 2Q'14, up from 9% in the sequential quarter. This was due to a mix of higher earnings and improvements in accumulated other comprehensive income (AOCI) as well as lower risk-weighted assets (RWA).

While Fitch views this favorably, it also notes that higher litigation costs over time have constrained much of BAC's potential growth in capital, which could still occur over the near term given the currently outstanding legal issues facing the company.

Additionally, BAC is in compliance with supplementary leverage ratio (SLR) proposals at both the holding company and main operating subsidiaries in the U.S.

Additional information is available at www.fitchratings.com.

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Contacts

Fitch Ratings
Primary Analyst
Justin Fuller, CFA, +1 312-368-2057
Senior Director
Fitch Ratings, Inc.
70 W Madison Street
Chicago, IL 60602
or
Secondary Analyst
Julie Solar, +1 312-368-5472
Senior Director
or
Media Relations:
Brian Bertsch, +1 212-908-0549
brian.bertsch@fitchratings.com

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Contacts

Fitch Ratings
Primary Analyst
Justin Fuller, CFA, +1 312-368-2057
Senior Director
Fitch Ratings, Inc.
70 W Madison Street
Chicago, IL 60602
or
Secondary Analyst
Julie Solar, +1 312-368-5472
Senior Director
or
Media Relations:
Brian Bertsch, +1 212-908-0549
brian.bertsch@fitchratings.com