Bank of America Earnings Call Insights: Capital Ratio, Net Interest Income

On Wednesday, Bank of America Corporation (NYSE:BAC) reported its third quarter earnings and discussed the following topics in its earnings conference call. Take a look.

Capital Ratio

Moshe Orenbuch – Credit Suisse: Just some extraordinary performance on the capital ratio, wanted to kind of talk about that a little bit. Did I hear correctly that the 8.97% is inclusive of the terms of the NPR?

Bruce R. Thompson – CFO: That’s correct.

Moshe Orenbuch – Credit Suisse: So as you think about that going into – I mean I heard that in some notes that there were some kind of benefits that could be somewhat temporary, but obviously over the next several quarter, one would expect that to continue to improve. Could you talk a little bit about whether you’re looking for improvement either in RWAs or your deductions and then also how you think about that since you’re likely to be more or less for either now or certainly in the coming months at the levels that you’d be required by the combination of Basel 3 capital requirements and the SIFI buffer?

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Bruce R. Thompson – CFO: When we look at the ratio – let’s talk first about the numerator then we can go to the denominator. As I said, there was about $3 billion on the numerator of the $8 billion that related to things that we benefited from rates. We’ll obviously see how that goes going forward, but I do just want to make sure that there was $3 billion there. On the numerator side because of where we are with respect to having NOLs as we go forward where we’re going to be different than most of our peers is on the numerator side our pre-tax income is going to tend to approximate the net income as it relates to capital build. So, we’ve got benefits going forward relative to our peers based on using those NOLs, which is, as you all are aware, are excluded from a Basel perspective. On the denominator side, there are three things that we would also continue to benefit from as we look to drive this number higher. The first is, on the retail credit side, we noted here during the quarter that we had about $27 billion of benefit and risk-weighted assets through both the reduction in consumer exposures as well as improvement within the credit portfolio that we saw on the consumer side and as we continue to reduce nonperforming mortgages as well as one of the consumer credit portfolios in the card business we’d look to continue to have benefit there. The second thing is that the structured credit in some of the legacy books will continue to runoff between now and 2017, we’ll benefit from that, and then third, there obviously continues to be a lot of work that’s done with respect to models in developing the systems to make sure that your measurements are appropriate here, so we feel very good about the capital build during the quarter, and we think as we go forward that the ability to continue to optimize and drive that Basel 3 number continues to have real opportunity for us.

Moshe Orenbuch – Credit Suisse: Just a follow-up on that, that’s great on the tactical side. What about strategically now that you are pretty much where you need to be, how do you think about that capital level differently and do you think about it in terms of your approach towards allocating to businesses or distributions and how should we think about that?

Bruce R. Thompson – CFO: One of the things that we highlighted and I’m going to speak first on Basel 1 to that question, that over the course of the last couple quarters, as we look to optimize our Basel 1 ratio, we were obviously very tight and have fairly firm limits on loan growth as we look to optimize the balance sheet. As we’ve gotten the balance sheet to where we want it to be that clearly pursuing loan growth in this rate environment is very much a priority, and if you look at what we did during this quarter, it’s the combination of several quarters and work we started to see good loan growth within the GWIM business. We saw the increases in mortgage production not all of which is loan growth, but some of it is loan growth, and then on the banking and market side, where loan growth was extraordinarily strong. So we’re using the strength and the balance sheet to look to drive growth in the loan side. We’re obviously doing it in a prudent way with borrowers that they have credit quality that we should be extending to and you’ve seen the results of some of that. On Basel 3 and as we work through Basel 3, a little bit of shift in mindset and that you’re looking to optimize and consider both, how things get measured as well as under Basel 3 as Basel 1, Basel 3 going forward is going to be the governor on capital distributions, so we’re obviously very mindful to be managing the balance sheet with Basel 3 front of mind. We’re obviously at a point at the end of the quarter, upwards of 9%, where we’re very close to or in excess of the stated minimums we’ll need to see where the SIFI buffer comes out, we think we positioned ourselves very well for both growing the business as well as we look forward going through the CCAR process.

Moshe Orenbuch – Credit Suisse: So that should mean that if this process is ongoing that you would expect to see loan growth accelerate modestly from here?

Bruce R. Thompson – CFO: I’m not going to suggest on an annualized basis that we saw commercial and corporate loan growth of 10% that you are going to see it accelerate, it can bump around a little bit in any quarter, but there you should expect and know that internally with those areas that have returns, we are pushing and looking to drive loan growth, that’s correct.

Brian T. Moynihan – CEO: I’d add that, the impact of the portfolios that we had identified going back a couple of years to runoff, which helps from the capital because, as Bruce said earlier, they were actually providing capital, it’s less now than it was then, because they are either smaller and the quarterly runoff is more muted which then allows the loan growth to come through the bottom line. So think about the card business for example, we get into place where we have got it pretty well positioned where we want and I think (what Bruce stated here, 75,000) new card customers this quarter, a little bit more than we did last quarter and we are driving with very high credit quality exactly what we want and we’re driving that out there. So as you think about the ability to show loan growth through the sort of the all of the ins and outs of the runoff portfolios, that’s what we’re just starting to see too as we are those things are getting smaller as a whole.

Net Interest Income

John McDonald – Sanford Berstein: Bruce, on the net interest income, you said that the $10.5 billion is a good starting point for the fourth quarter NII?

Bruce R. Thompson – CFO: That’s correct, John.

John McDonald – Sanford Berstein: I guess what are the puts and takes from there. Did you say that you hope to get some debt reductions or the benefit on debt reductions could offset the headwinds that you expect from low rates in runoff, did I hear that right?

Bruce R. Thompson – CFO: Sure. During the third quarter, we had $6.2 billion as I mentioned the TruPS that occurred during the quarter in $12 billion of stated maturities. We’ll have the full benefit of those during the fourth quarter as opposed to just a partial benefit. The second thing is, the redemption of TRUPs will have the $50 million benefit that I mentioned in the fourth quarter and we are continuing to push deposit pricing down, so that’s a benefit as well. So as we look at the fourth quarter absent any unexpected decline in rates and any impact of negative hedging effectiveness or FAS 91, we would expect net interest income to be at least in the fourth quarter than what it was in the third quarter.

John McDonald – Sanford Berstein: What about next year on NII, Bruce. Do you have additional tools on the cost funding side? Do you hope to keep that $10.5 billion run rate or grow or see some pressure from that? Could you give us some perspective for next year?

Bruce R. Thompson – CFO: We’re managing the portfolio to look to be able to continue to have modest increases in NII for what we’re doing on the debt footprint as well as deposit pricing. So, the goal is to continue to push that up. We think we’ve got a good plan in place to continue to do that. We obviously can’t predict interest, but if they were to stay where they are and the forward curve were to materialize, we think we’ll be successful in doing that.

John McDonald – Sanford Berstein: Then switching over to expenses, do you have any sense of where you might be on the litigation reserve build cycle later innings or any way to frame that for us?

Bruce R. Thompson – CFO: The Merrill Lynch class action settlement was a significant litigation item to get behind us. As you look at litigation going forward, we’ve narrowed it with this settlement in large part that they’re – there are cases obviously outside of mortgage, but largely the majority of the litigation that we have now with the Merrill Lynch settlement is within the mortgage area. We obviously provide reserves for what we think we have and in the disclosure, we give guidance on range of possible loss for what we’d expect within the litigation area and we continue to work through those. With where we’ve built the balance sheet, obviously getting these behind us is something that we’d like to do, but we’re only going to do it in a way that makes sense for the shareholders.

John McDonald – Sanford Berstein: Then on the LAS side, you mentioned that with the 60-plus delinquents moving down you should start to see the LAS expenses come down next quarter?

Bruce R. Thompson – CFO: From an operating basis, John, we saw the first decline in FTE. You can see the contract is a little higher. The third quarter was a lot of work because it was a combination of the Department of Justice, the (timely MOD) work and also just the general work. But as we look at it even since the quarter end we have seen the headcount start to come down already even further. So, this thing has been a lot of work from an operating basis. We’d say from the numbers of people and stuff like that, it’ll be down in the fourth quarter. The question is from the litigation perspective, those are the things bounce around a little bit if you look across all the last quarters. But from an operating basis, we’ve already reduced the headcount in the fourth quarter from where it was in the third quarter.

John McDonald – Sanford Berstein: So I guess from total expenses all-in jumping off-point for the fourth quarter, if we adjust for our own estimate of litigation reserves versus what would you think would be a number for the expenses to jump off from?

Bruce R. Thompson – CFO: I think if you adjust for the litigation expenses, those are going to be a good place to jump off from and as Brian referenced, we think that there is the opportunity within the LAS area to start driving those expenses down in the fourth quarter and clearly into ’13.

Brian T. Moynihan – CEO: John, the way we think about it, as we look at year-over-year, third quarter last year to third quarter this year, we had sort of flat expenses. But if you look at the impact of the increase in litigation, increase in LAS, the rest of the Company is down $1 billion or so in operating expenses and that will move up or down because if we have a better trading quarter, we could some more compensation there. But you are seeing the impacts of new BAC plus the other initiatives in the Company taking the expenses down and we’re just continuing to work at it. That being said, we’re still making investments in this Company to make sure that we’re doing the right thing to have the franchise that won’t be coming out of it. So more loan officers, FSAs, preferred bankers and $3 billion plus in systems development work this year, $700 million to $800 million of which is going to help us to get expense base down in future years. So, we are trying to balance that, but you can see the expenses from the core base is what you’re pointing out continuing to trend down and we’re feeling better about that. The best news in this quarter is we think as you look at the LAS, you see that the breakpoint here and we’ll say, we’ll keep driving that down in the fourth quarter.

John McDonald – Sanford Berstein: Last thing from me is, on the mortgage banking fee results, Bruce, could you drill that a little bit for the drivers of the strong mortgage banking fees? You mentioned the origination volumes, just what you saw, gain on sale margins and then also how do the MSR hedge gains contribute and was your business sale as well that you mentioned?

Bruce R. Thompson – CFO: Sure, within mortgage banking we did see a business sale that was about $175 million of a small ancillary business that materialized in the quarter. The second thing is, with respect to mortgage margins, they stayed relatively firm in the third quarter relative to the second quarter given the activities that the industry had industry wide. The third point of your question is, if you go and look at Page 26 of our supplement, when you mentioned the MSR hedge, that relative to the last couple quarters we were about $350 million better in the third quarter than we had been the prior several quarters and we detailed that on Slide 26.

Brian T. Moynihan – CEO: John, one thing I’d say, tying those two questions together, on the originations side you can see the volumes coming up, but we’ve added 3,000 more people during this year than we through we’d have in the underwriting fulfillment side of the good mortgage side to help us get the volumes going and those people continue to come on stream. So our capacity to grow there is expanding and some of the people that we’re – and they’re all in the headcount numbers you see, but some people were taking out LAS for converting to the first mortgage business, because the team need to experience the mortgage and to help build our capacity, like a lot of our colleagues, the volume levels have been high and our capacity get them close with the underwriting standards has been a lot of work and so we’ve added 3,000 or 4,000 people, I think at this point than when we thought we’d be this year and we’ll continue to do that to capture the revenue (before that).

A Closer Look: Bank of America Earnings Cheat Sheet>>