Fitch: Litigation Charges Mar Bank of America's 1Q'14 Results

Bank of America Corporation's (BAC) stated first quarter 2014 (1Q'14) earnings swung to a net loss applicable to common shareholders of $514 million due to significant litigation charges incurred in the quarter, according to Fitch Ratings. This loss was surprising and reversed the trend of improving stated earnings over the last several quarters, Fitch would note the last couple of which had also been significantly aided by reserve releases.

Specifically, BAC incurred a $3.6 billion incremental charge to 1Q'14 earnings in conjunction with its previously announced settlement with The Federal Finance and Housing Administration (FHFA). Separately, BAC also incurred an additional $2.4 billion charge related to boosting litigation reserves due to legacy mortgage-related litigation, which was outside of Fitch's expectations for this quarter's earnings.

Fitch calculated pre-tax profits, which excluded CVA/DVA adjustments, securities gains, and some litigation charges amounted to $4.9 billion in 1Q'14, which equated to a 0.91% pre-tax adjusted return on assets, which is an improvement relative to the sequential and year-ago quarters. However, if Fitch includes the $2.4 billion charge noted above, which it had not contemplated, BAC's adjusted Fitch calculated pre-tax income would have been $2.5 billion, which equates to a 0.46% adjusted return on assets. This is down from the sequential quarter and somewhat inline with the adjusted return on assets of the year-ago quarter, which included charges related to a settlement with MBIA.

Based on either calculation, Fitch would note that BAC's core earnings performance continues to be below that of peer institutions during 1Q'14, and Fitch believes that this relatively weaker core earnings performance constrains upwards rating momentum. Fitch would expect incremental litigation costs to continue to weigh on BAC's earnings over a near-to-intermediate term time horizon. Over a longer period of time as BAC eventually incurs fewer litigation costs and continues to execute on its efficiency initiatives, Fitch believes that it is possible for the company's earnings to improve to peer levels and come closer to Fitch's long-term cost of equity assumption for BAC.

Notwithstanding the litigation issues noted above, 1Q'14 core earnings were mixed. BAC's stated net interest income (NII) was down from both the sequential and year-ago quarter. In the year-ago quarter, lower overall asset yields more than offset reductions in funding costs. Non-interest income was more mixed as continued strength in BAC's wealth and investment management unit was offset by weaker year-over year performance in Fixed Income Currency & Commodities (FICC) results, relatively flat equities trading results, and the continued and expected decline in mortgage banking results.

While expenses were impacted by the charges noted above, BAC did reasonably well in managing its core expense base during the quarter.

However, BAC's overall provision expense for credit losses did increase to $1 billion during the quarter, as more moderate reserve releases related to mortgage and home equity loans were in part offset by some reserve build relative to the sequential quarter related to the company's higher commercial loan balances.

Fitch continues to note that BAC's liquidity profile with more than $1.13 trillion in deposits continues to be a relative strength of the company. Additionally, Fitch expects that BAC may further reduce its long-term debt footprint over the balance of the year.

BAC's earnings and capital position continue to absorb the company's litigation losses noted above, and held relatively steady during the quarter. Due largely to some modest reductions in the loan portfolio, BAC's Basel III Tier 1 Common (CET1) ratio under the standardized approach was 9.3% in 1Q'14, modestly up from the 9.1% ratio at year-end (YE) 2013. Under the advanced approach BAC's Basel III CET1 ratio was 9.9%, down modestly from 10% at YE2013, due in large part to higher operational risk charges in the calculation of risk weighted assets (RWA) under the advanced approach. Fitch continues to expect that over a medium term time horizon, BAC's binding capital ratio will be the standardized ratio under Basel III.

Fitch continues to note that while BAC's capital position has been able to absorb the company's legal charges, the company's capital ratios remain below those of global peers. Fitch would expect that should legal charges eventually abate, BAC's capital position could improve to at least peer levels over time, which Fitch would view positively from a credit perspective.

Additional information is available at www.fitchratings.com.

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