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Bank of America's (BAC) CEO Brian Moynihan on Q4 2015 Results - Earnings Call Transcript

Q4 2015 Results Earnings Conference Call

Executives

Lee McEntire - Investor Relations

Brian Moynihan - Chairman and Chief Executive Officer

Paul Donofrio - Chief Financial Officer

Analysts

Matt O'Connor - Deutsche Bank

Betsy Graseck - Morgan Stanley

John McDonald - Bernstein

Paul Miller - FBR Capital Markets & Co.

Jim Mitchell - Buckingham Research

Glenn Schorr - Evercore

Steven Chubak - Nomura

Eric Wasserstrom - Guggenheim

Ken Usdin - Jefferies

Brian Foran - Autonomous Research

Brennan Hawken - UBS

Mike Mayo - CLSA

Operator

Good day, everyone, and welcome to today's Bank of America earnings announcement. At this time all participants are in a listen-only mode. Later you will have the opportunity to ask questions during the question-and-answer session. [Operator Instructions] Please note that this call may be recorded. I'll be standing by if you should need any assistance.

It is now my pleasure to turn the conference over to Mr. Lee McEntire.

Lee McEntire

Good morning. Thanks to everybody on the phone, thanks for those that are joining us on the webcast as well. Welcome to the fourth quarter earnings results presentation. Hopefully, everyone has had a chance to review the earnings that we released. It is available on the Bank of America Investor Relations website.

And so before I turn over the call over to Brian and Paul, let me remind you we may make some forward-looking statements. For further information of those, please refer to either our earnings release documents on our website or our SEC filings.

So with that, I will turn it over to our CEO, Brian Moynihan.

Brian Moynihan

Thank you, Lee, and good morning. Thanks to all of you for joining us this morning to discuss our fourth quarter results. Before Paul Donofrio takes you through the details of the quarter, I just want to provide some overall context on our progress in 2015 and the opportunities and challenges ahead.

As you know, for the fourth quarter, we reported $3.3 billion in earnings or $0.28 per diluted share. For 2015 we had net income of $15.9 billion, that's the highest net income we've had in a long time. Full year return metrics were 74 basis points for ROA and 9% for return on tangible common equity.

During 2015 we continued to drive our 8 lines of business forward. We've focused on driving responsible growth across all our businesses and as you look at the annual earnings of the company and see how they fell, you can see how they came through.

Our consumer and wealth management businesses serving mass market customers all the way to the wealthiest Americans delivered $9.3 billion in net income this year. Our Global Banking business which provides services to small, medium and large companies around the world, produced $5.3 billion in net income this year.

Within our institutional investor clients our markets business with its market leading research capabilities and the top tier platform across the globe delivered $3 billion in earnings after adjusting for DVA in a very challenging market.

What's clear in these earnings despite the gyrations of markets especially at the end of the year last year is annuity nature that we get from our franchise by driving customer and client flows. That's the power of our company, it’s balancing the scope and a strong customer base and we aim to continue to improve it every day for our clients and customers and our shareholders. These results reflect the work we've done over the past several years to develop a more straightforward and simplified operating model and focus on responsible growth.

As you see on slide 2, across the variety of measures, loan growth business activity, capital liquidity, credit losses and cost management, we've made meaningful progress and believe we are positioned for a variety of economic cycles. At the foundation of all this is a strong capital and liquidity base. We added to our record liquidity levels in 2015 and we believe we are well positioned against the 2017 LCR requirements with total global excess liquidity sources now at over $500 billion. This amount represents nearly a quarter of our balance sheet and we now have enough [indiscernible] liquidity to last more than three years before we need to tap the market for funding.

Now our liquidity levels were driven by strong growth in deposits this year and we were able to put that funding to work to grow loans on an absolute basis for the first time in several years. Loan growth was all driven by organic activity and is consistent with our risk posture.

Our tangible common equity of $162 billion is at record levels as well. We returned $4.5 billion to shareholders this year in common dividends and share repurchases. Our tangible book value per share improved 8% in the past 12 months to a new high of $15.62. Our responsible lending focus also shows in our underwriting results. Our net charge-offs were down just $4.3 billion this year, consistent with 2014 but much lower than previous years.

Commercial charge-offs increased off a very low base mostly from oil related charge-offs while consumer losses as a core continued to improve. This reflects further responsible underwriting as continued improvement in our legacy portfolios.

And finally we get to the cost management side. At the heart of our work has been improving expenses which you can see are down sequentially from last year mostly on lower litigation costs, but also on improved LAS and other operating costs and these have improved steadily across the last several years.

We began new a BAC in 2011 and completed it in 2014. Since then we have been using our Simplify and Improve initiatives to find savings that more than offset increased compliance, merit and other inflationary costs. But most importantly those savings fund investments in our business whether it is in technology or sales force growth or other infrastructure costs.

As we move to slide 3, we included a few examples of trends, business activity in our consumer side of the house and wealth management side of the house. As you can see, we grew average deposits in consumer banking and wealth management business is $52 billion or 7% comparing year-over-year fourth quarter periods. These deposits were up over $105 billion in core deposits at the end of 2012.

This strong organic growth is the result of hard work in improving the customer satisfaction in our franchise by making it easier for customers to do business with [indiscernible] and strong product management simplifying the product set. All this has been done, where we've optimized our delivery networks, reducing our financial standards, divesting certain markets and also expanding our award winning mobile capabilities in the customer base that uses that.

As you can see this work also extends to our wealth management business. We had long-term net flows every quarter for six and a half years in wealth management. We have record loan levels and significant higher deposit levels, good products and [advisers] [ph], a growing sales force and two of the leading brands in business positions us well here..

Let me move to our global banking markets area. You can see on the institutional side of the [house] [ph] that’s set out forth on slide 4, we saw solid activity in 2015. Loans to commercial and corporate clients around the globe are growing nicely. Client demand has been good and our bankers have met our challenge to capture market share responsibly. This focus allows us to demonstrate a strong 12% growth in loans through global banking in the past 12 months and you can see the deposit growth has been strong here in the last year as well.

If you look at the markets business Tom Montag and team have done a good job of reducing assets and lowered the risk and still are generating relatively stable revenues. Despite the recent market challenges we remained quite profitable in this business and well positioned around the globe with both a strong [FICC] [ph] and equity platform.

As we step back we remain focused on our core customer strategy. We will continue to invest in the future and even as we continue to address the legacy issues of the past. We've been able to grow even as operating and economic environment remains in a low growth mode. Our model is solid but there is still plenty of work to do, but also there is plenty of opportunity ahead for us.

Overall I am pleased with the progress made in 2015 and we have more to do in 2016. In 2016 you should expect us to continue to focus on responsible growth. We will continue to drive the investments made in our franchise to deliver the value to you the shareholders. We will continue our sharp focus on risk management and we will continue our cost discipline as we look to continue to improve return on capital – capital metrics of our company.

With that, let me hand it over to Paul.

Paul Donofrio

Thank you, Brian, and good morning everyone. Starting on slide 5, we present a summary of the income statement and returns for this quarter as well as the fourth quarter of last year which had similar seasonal aspects. We earned $3.3 billion in the quarter compared to earnings of $3.1 billion in 4Q 2014. Earnings per diluted share this quarter were $0.28, up 12% versus a year ago.

The results include two significant charges that were previously announced and impacted EPS by $0.06. First, we recorded a pretax charge of $612 million associated with trust preferred securities which phased out of tier two capital at the end of 2015. Second we had a tax charge of $290 million associated with the UK tax changes that were enacted during the quarter.

Lastly we had a few other items that benefited the EPS this quarter by a penny on a net basis. These included a negative net DVA impact in sales and trading that was more than offset by positive impacts of market related adjustments in net interest income and some one-off tax benefits.

Revenue on an FTE basis was $19.8 billion this quarter up 4% from Q4 2014. Expenses were $13.9 billion approximately $300 million or 2% lower than a year ago driven by good expense discipline across the company.

We also provide returns and a few other metrics on this page, I would remind you that client activity and revenue in our global market segment tend to be lower or lowest in the fourth quarter affecting returns on other statistics.

Lastly, as many of you are aware, there was a recent accounting change that required certain unrealized debit valuation adjustments to be recorded directly to OCI rather than through the P&L. We early adopted this change effective as of the beginning of 2015. The slide and the supplemental earnings material that was in 2015 results have been adjusted.

Turning to slide 6 and focusing on the balance sheet, we grew deposits by $35 billion from Q3 and we used these increased deposits to fund responsible loan growth. In total assets climbed $9 million as increases in loans and security balances of $30 billion were more than offset by reductions in trading related assets and cash.

Liquidity rose to just over $500 billion, a record level, and time to required funding remains over three years. Tangible common equity of $152 billion improved modestly in Q3 as earnings were offset by both the return of $1.3 billion in capital to common shareholders and negative OCI driven by security values. Tangible book value per share increased to $15.62, another new record high.

Turning to regulatory metrics we began recording regulatory capital under the advanced approaches for the first time this quarter, and the CET1 transition ratio under Basel 3 ended the quarter at 10.2 and really has no comparable metrics as transition ratios in prior periods were reported under the standardized approach with lower RWA levels. On a fully phased-in basis, CET1 capital improved modestly to $154.1 billion under the advanced approaches compared to Q3 2015 pro forma estimates the CET1 ratio increased slightly to 9.8%. RWA was essentially flat as growth from commercial exposures was mostly offset by lower activity and balance sheet levels in our global markets segment.

We also provide our capital metrics under the standardized approach. Here our CET1 ratio was flat at 10.8% with modest improvements in capital offset by modest increase in RWA. In terms of the supplementary leverage ratios we estimate that as of 12/31 we continue to exceed U.S. rules applicable beginning in 2018 at both the parent and bank.

Turning to slide 7, we had strong loan and deposit growth this quarter. Reported loans on an end of period basis increased $15 billion from Q3. This is the third consecutive quarter of recorded increases in total loan balances. We continue to see solid loan demand in our primary lending businesses partially offset by runoff in LAS and all other.

Excluding declines in LAS and all other, ending loans in our primary lending segments increased $22 billion from Q3. $8 billion of this increase was in consumer loans as GWIM increased mortgages and security based lending. Consumer banking also saw good loan growth in mortgages as well as vehicle loans.

We also had some seasonal growth in credit card partially offset by selling $1.7 billion of card receivables at the end of the quarter. Commercial loans grew $15 billion spread across multiple industry groups.

Turning to deposits, on many basis they reached nearly $1.2 trillion this quarter growing $78 billion or 7% in Q4 2014. Growth was solid across the franchise. Consumer led the way growing 9% year-over-year while global banking and GWIM each grew at 6% pace.

Turning to asset quality on slide 8, while still strong we did see net charge-offs increase modestly from recent levels. Total net charge-offs increased $212 million versus Q3, $144 million was from consumer items previously reserved for and lower recoveries on the sale of NPL in the fourth quarter versus Q3. We also saw a $73 million increase in net charge-offs from our energy portfolio. Outside of these two areas, net charge-offs were stable compared to Q3.

Provision of $110 million in Q4 was relatively flat with Q3. Reserve releases in consumer real estate and credit card were partially offset by reserve builds in commercial which was driven by increase in criticized exposures as well as loan growth. Reserve releases excluding the previously reserved items I mentioned earlier were roughly $200 million.

On slide 9 we provide credit quality data on our consumer portfolio. Net charge-offs increased $137 million. The two items of note that make up this increase were reserved for in prior periods and did not impact the provision expense in the quarter. $119 million was the result of collateral valuation adjustments. In addition, we had some small charge-offs associated with our 2014 DOJ settlement. We expect to complete our commitments under this settlement in the first half of 2016.

Adjusting for these two items, consumer net charge-offs were relatively flat versus Q3. Delinquency levels and NPLs continue to decline and reserve coverage remained strong.

Moving to our commercial side, on slide 10, net charge-offs increased $75 million primarily from losses in our energy portfolio. Outside of the energy portfolio, commercial losses remained very low. Given the focus on the impacts of low oil prices on companies in the energy sector, we want to spend a minute to describe our energy portfolio and provide some perspectives.

The pie chart break down our $21 billion utilized exposure to the energy sector. This represents a little more than 2% of our total loan balances. Within that $21 billion $8.3 billion or less than 1% of the total loans is loans to borrowers in two subsectors, Exploration and Production as well as Oil Field Services. We consider these two subsectors to have significantly higher risk than the rest of the energy portfolio.

Of our $8.3 billion utilized exposure to these two higher risk subsectors $2.9 billion has already been downgraded to criticized. So 35% of the higher risk subsectors has already been downgraded to reservable criticized exposure thereby driving a portion of the reserves. And allowances for loan losses for the entire energy portfolio is approximately $500 million or 6% of the funded exposure of these two subsectors.

The company in the vertically integrated subsector represents $5.8 billion of the energy portfolio. We believe this subsector has a better ability to withstand lower oil prices. Nearly 100% of the companies have a market capital of $10 billion or more or they are sovereign owned and the average company has a market cap greater than $60 billion. We believe the remaining exposure in Refining and Marketing as well as other is also less dependent on oil prices.

As part of our standard risk management process, we stress test our credit portfolios including our energy portfolio. Our stress analysis of the energy portfolio includes various sustained low oil prices over extended periods. As an example, if we held oil prices at $30 per barrel for nine quarters we estimate our potential losses on the energy portfolio would be roughly $700 million.

In energy and across our commercial sector, we continue to support clients while managing lending limits and actively engaging with stressed borrowers. Before moving from asset quality I want to refocus on total provision expense and how one should think about it over the next couple of quarters. As we continue to assess and react to future changes in the energy sector we could see lumpiness that could potentially drive provision expense over $900 million.

Turning to net interest income on slide 11, on an FTE basis NII was $10 billion increasing roughly $300 million from Q3. NII included a negative $612 million charge associated with three trust preferred securities. These securities were scheduled to be completely phased out of tier 2 capital as of January 01, and with 7% to 8% coupons became expensive debt. NII also included a $150 million of positive market related adjustments to the amortization of bond premiums under FAS 91.

NII excluding market related adjustments and the charge on the trust preferred improved $188 million from Q3 to $10.5 billion. This improvement was driven by increased deposit balances which we used to fund growth in loans and securities.

As we move into the first quarter, please note the following: first, we will have one less day of interest. Second, recent changes by Congress will lower the amount of dividends we receive from the FRB by approximately $50 million a quarter. Having said that, if the forward curve is realized and if we have some modest deposit and loan growth we still expect to show some growth in NII in Q1 2016 relative to our adjusted NII of $10.5 billion.

With regards to asset sensitivity, at the end of the fourth quarter our overall asset sensitivity decreased slightly as a result of increases in long-end rates as well as security balances. As of 12/31 an instantaneous 100 basis points parallel increase in rates is estimated to increase NII by approximately $4.3 billion over the subsequent year. Although more than half of that improvement comes from the increases in short-end rates and a little less than one quarter of the benefit comes from market related adjustments.

Turning to expenses on slide 12, non-interest expense was $13.9 billion in Q4, $300 million lower than Q4 2014. This was driven by good expense discipline across the company. Litigation expense was a little higher this quarter at $428 million exhibiting some lumpiness as we work to resolve legacy issues. Keep in mind that annual litigation expense decreased from $16.4 billion in 2014 to $1.2 billion in 2015. Legacy asset servicing cost excluding litigation finished Q4 a little better than our targets of $800 million. As we have said, our net goal is $500 million per quarter.

Expenses excluding litigation and LAS were $12.6 billion and represents the fifth quarter out of the past six below $12.8 billion. We continue to look for ways to streamline and simplify how we do business. This is important because it allows us to invest in growth while maintaining relatively flat core expenses and a sluggish revenue environment. And importantly this relevant flatness continued even as we invested in additional sales professionals and improved technologies.

Looking towards expenses in 2016 let me remind you, in the first quarter we will record as normal approximately $1 billion in cost for retirement eligible incentives. In addition, the first quarter strictly includes seasonably higher payroll taxes of roughly $300 million. And if we experience traditional rebound in Q1 sales and trading revenue, this would also increase incentives and other associated costs.

Turning to the business segments and starting with consumer banking on slide 13, consumer earned $1.8 billion, 9% greater than Q4 last year. These results reflect good operating leverage on increased customer activities. The segment generated a strong 25% return on allocated capital. Revenue of $7.8 billion was up modestly from Q4 2014.

Net interest income benefited from higher deposit and loan levels. Noninterest income was down slightly from lower mortgage banking. The decline in mortgage revenue reflects selling fewer nonperforming loans as we hold more on our balance sheet. In addition there was absence of $30 million in quarterly from the Q3 sale of the small noncore appraisal business.

Expenses declined 2% from Q4 2014 as the savings from reduction in financial centers and personnel more than offset higher product costs and investment in increased sales specialists. The cost of operating deposit franchise remains low at 177 basis points. Operating leverage drove improvements in the efficiency ratio of 56% as we continue to experience shifts in customer activity away from branches towards self-serve options.

Mobile banking users increased to 18.7 million which is up 13% from Q4 2014 and deposit transactions from these devices now represent 15% of deposit transactions.

Slide 14 presents consumer progress across a number of customer activities. I will highlight activities in three areas, loans, deposits and brokerage assets where we continue to grow responsibly. These three products are at the core of our rewards programs where we share benefits with customers who deepen relationships with us. Average loans grew $12 billion from Q4 2014 in mortgages and vehicle lending. And in deposit growth was strong at $48 billion or 9% from Q4 while the rate paid declined to 4 basis points.

Regarding brokerage assets, Merrill Edge assets levels of $123 billion are up 8% from last year even with declines in equity markets this year. Total mortgage production was up 13% from Q4 last year and stable with Q3.

Looking at card activity which includes GWIM, card issuance was strong at $1.3 million. Average U.S. card...


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