Fitch: Litigation Expenses Absorb Bank of America's 3Q'14 Earnings

CHICAGO--()--Bank of America Corporation's (BAC) stated third quarter 2014 (3Q'14) earnings of $0.2 billion were impacted by the previously announced settlement with the Department of Justice (DOJ) due to mortgage related matters. While some of this settlement had been reserved for earlier in the year, this settlement along expenses for other smaller litigation expenses amounted to $5.6 billion of litigation costs and $0.4 billion of incremental provision in the quarter, which collectively absorbed nearly all of the company's earnings this quarter.

Fitch calculated pre-tax profits, which exclude CVA/DVA adjustments and various other gains/losses amounted to $0.2 billion, or a 0.04% adjusted return on assets (ROA). For comparison purposes excluding the litigation charges/costs noted above would yield a 1.17% adjusted ROA, which is good, though below last quarter's 1.28% adjusted ROA excluding legal charges. Fitch does note that excluding the company's recurring legal expenses, management continues to make progress on putting the company's legacy issues behind it and streamlining BAC's operations.

Should BAC's legal costs begin to abate, which given currently disclosed outstanding legal matters Fitch views as possible, the earnings power of the company's strong franchises will be more evident. That said, BAC has also had to endure a number of unforeseen legal issues over the last several years which will continue to bear monitoring.

Importantly, BAC's Basel III Common Equity Tier 1 (CET1) fully phased-in ratio under the standardized approach modestly increased to 9.6% from 9.5% despite the previously noted litigation charges primarily due to lower risk-weighted assets (RWA). Fitch believes the RWA decline was due to the disposition of some non-performing loans, the paydown of some loans whose proceeds were re-invested into lower risk-weighted securities, a reduction in low-yielding prime brokerage loans and trading related assets, as well as other steps that further reduced the company's balance sheet.

BAC's Basel III CET1 fully phased-in ratio under the advanced approaches decreased to 9.6% on the quarter, which is now inline with the standardized approach, due to additions to operational risk RWA. This increase in operational risk RWA was due in large part to the inclusion of the aforementioned settlement with the DOJ into the company's operational risk calculations.

During the quarter, BAC also took some balance sheet actions in preparation for compliance with the recently final Liquidity Coverage Rule (LCR). This included converting some insured residential mortgage loans into agency securities, reducing deposit balances that are less LCR friendly, and increasing the mix of U.S. Treasuries in its securities portfolio. Fitch continues to believe that BAC will be in compliance with the LCR when the rule goes into effect in January 2015.

While BAC's Global Banking and Global Markets businesses showed good year-over-year growth, as expected the comparisons to the sequential quarter were more challenging. Fitch would also note that the sequential quarter comparisons of these businesses also do not compare as well to some other banks that have reported to date.

Fitch continues to note that the company's Global Wealth & Investment Management (GWIM) businesses continues to be a bright spot with good revenue growth, strong client asset gathering, as well as a strong pre-tax margin relative to competitors. Fitch would expect GWIM to continue to perform well, though its results are likely to be modestly volatile given its exposure to equity markets, which have been more volatile as of late.

Fitch would note that BAC's management continues to make progress in reducing its operating expenses (not including litigation costs), which Fitch believes is a key lever management can pull to improve the company's long-term earnings power. These expense savings were primarily realized in the company's Legacy Asset & Servicing (LAS) area, which Fitch would expect to continue to decline over time, as well as through 'New BAC' initiatives.

Collectively, these efforts included some headcount reductions in LAS during the quarter as well as the continued optimization of the company's branches, which declined by 76 branches relative to the sequential quarter.

Fitch continues to believe that to the extent that these efforts are successful and not absorbed by unforeseen litigation, it's possible for the company's returns to approach peer levels over a longer-term time horizon and to also come closer to Fitch's estimate of BAC's long-term cost of equity assumption of between 10%-12%.

Additional information is available at www.fitchratings.com.

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Contacts

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

Contacts

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