Bank Of America Corp (BAC) — Q3 2018 Earnings Call Transcript

Good morning. Thanks for joining this morning’s call to review our 3Q ‘18 results. By now, I hope everybody has had a chance to review the earnings release documents on the Investor Relations section of bankofamerica.com website. Before I turn the call over to our CEO, Brian Moynihan, let me just remind you that we may make forward-looking statements during the call. After Brian’s comments, our CFO, Paul Donofrio will review the details of the third quarter results. We’ll then open up for questions. For further information on our forward-looking comments, please refer to either our earnings release documents, our website, or our SEC filings. With that, take it away, Brian.

Thank you, Lee. Good morning everyone and thank you for joining us to review our third quarter results. This is another quarter where Bank of America has successfully executed the core principles of our shareholder model. Year-over-year, we grew revenue slightly better than GDP. We also increased loans and deposits in our core business by similar margins. Additionally, we managed expenses effectively, achieving a 2% reduction year-over-year, while continuing to manage risk effectively, resulting in decade low credit costs. As a result, our earnings grew significantly; our pretax earnings rose by 18%, and we returned nearly all of those earnings to you, our shareholders. This capital return enabled us to reduce our share count by over 5% year-over-year and increase EPS at a rate faster than earnings. In the third quarter, our over 200,000 teammates excelled, generating $9 billion in pretax earnings, the highest quarterly amount in the company’s history. We achieved an 18% increase in pretax earnings compared to the same quarter in 2017. Our operating model proves effective, with pretax earnings growing each quarter for the past 11 quarters by an average of 15%. We are operating in a strong U.S. economy with low unemployment, rising wages, and solid consumer spending. Client engagement, optimism, and activity levels remain robust. This quarter, our net income reached $7.2 billion post-tax, a 32% increase from last year, and EPS increased to $0.66, up 43%. Our return on tangible common equity was 15.5%, a 450 basis point improvement over last year, and our return on assets was 1.23%. This year-over-year improvement was driven by 4% revenue growth, with net interest income leading at a 6% increase. The value of our deposit franchise is reflected in both our net interest income and net interest yield improvements, which Paul will elaborate on later. Our balance sheet remains strong in terms of both capital and liquidity, enabling us to pay $4 billion in common dividends and allocate $15 billion to reduce our share count so far this year, of which $6.5 billion was executed this quarter. On a diluted basis, our average shares decreased by 5% from last year. We have reduced our average diluted shares by $1.4 billion from their peak, with outstanding shares now below the $10 billion mark, a level we hadn't seen since the current management team took over in 2010. This quarter, we demonstrated good organic growth, achieving over 3% year-over-year growth in loans across business segments. While commercial loan growth moderated somewhat this quarter, it's important to note that many companies started the year with ample cash, continue to earn well, and are utilizing repatriated cash, along with tax savings, to manage their debt levels. We expect this liquidity to shift as the economy expands and the demand for capital expenditure increases. Furthermore, we averaged a 4% year-over-year increase in deposits, marking the 12th consecutive quarter of $40 billion year-over-year growth. This growth highlights our competitive strength. Of that $40 billion, consumer checking contributed $25 billion with over 8% growth year-over-year. Our checking balances have consistently increased since 2012, showing a 9% compounded annual growth rate during that time. Additionally, Global Banking deposits also grew significantly and wealth management continued to stabilize. We expanded our credit card and checking account offerings and surpassed the $200 billion asset mark in Merrill Edge online brokerage, having doubled those assets twice in the past eight years, and still having ample room for further growth. Overall, client balances in our wealth management division exceeded $2.8 trillion, with annualized net household growth in Merrill Lynch nearly four times higher than last year, along with increases in small business clients and balances. Small business originations, crucial for supporting our local communities, rose by over $2 billion this quarter, reflecting a 9% increase from last year. We also continue to acquire new commercial banking clients, reinforcing our optimism as we expand our customer base and deepen current relationships. Regarding credit risk, we sustained our strong credit culture and achieved responsible growth. Net charge-offs and ratios declined from the previous quarter, along with nearly every key asset quality metric. Our total expenses this quarter were $13.07 billion, bringing our trailing four-quarter expenses to $53.5 billion. We reached this run rate while investing in our shared success, which includes cash and stock grants to over 90% of our employees, and increased investments in technology, infrastructure, relationship managers, and physical facilities. Since announcing our goal for a $53 billion run rate in 2018 in the second quarter of 2016, we have successfully reached it, despite initial skepticism. I assure you that we will maintain this level. As we outline our plans for 2019 and 2020, we reaffirm that expenses will remain in line with the $53.5 billion trailing four-quarter figure. Achieving this requires discipline and strong execution from our team. Their ability to invest significantly while enhancing expense efficiencies has led to this success, creating operating leverage through disciplined customer service and innovation.

Good morning everyone. I’m starting on slide five. Bank of America reported net income of $7.2 billion or $0.66 per diluted share. Net income was up 32% from Q3 ‘17 and EPS grew 43%. Growth was strong, even if you adjust for the lower tax rate from the Tax Act. Year-over-year, pretax income, as Brian noted, reached a record $9 billion, up 18%. Once again, our year-over-year earnings growth was driven by strong operating leverage and strong asset quality. The 4% improvement in revenue was driven by NII improvement. And with expenses down more than 2%, we drove 700 basis points of operating leverage. Provision expense was $118 million lower than Q3 ‘17. NPLs, reservable criticized exposure, and delinquencies all declined while net charge-offs were up $32 million year-over-year, mostly from seasoning of our credit card portfolio and loan growth. The effective tax rate for the quarter was a little more than 20%. The tax rate in Q4 should be marginally higher, absent unusual items. Turning to the balance sheet on slide six. Overall, compared to the end of Q2, deposit growth of $36 billion drove an increase in assets of $47 billion. The deposits were invested in cash, investments as well as reverse repo. Liquidity remained strong with average global liquidity sources of $537 billion and the liquidity coverage ratio of 120%. Total shareholders’ equity decreased $2.1 billion from Q2. We returned 96% of net income available to common through a combination of dividends and share repurchases. Common equity was driven lower by $1.5 billion reduction in AOCI from the impact of higher long end rates on the value of our AFS debt securities. Preferred stock declined as redemptions of some higher yielding issuances caught up with the new preferred we issued in the first half at lower yields.

So, we should keep pushing it down to that level. Yes.

Look, we are optimistic. In Q4, we’re going to benefit from the September rate hike. We should also benefit from loan and deposit growth. I think, the only real question is how much of these benefits are going to be offset by rate increases on deposits.

Hi. Good morning. So, I was hoping to start off, Brian, with just a question on the investment banking strategy. There has been a lot of focus in the press on some of the senior personnel changes at the investment bank whether your lack of risk appetite maybe negatively impacted revenue growth? And I was just hoping you can maybe set the record straight.

I think, Paul actually can speak to this too, because he was a leader in that business. But, the team did a good job across the last several years of repositioning us after the crisis. Tom Montag has brought in a new leader to help carry us through the next level as we look forward. We know we can get our fair share out of that business. We got to keep it balanced, both domestically and internationally across the platform and make sure we are doing a great job in the United States because A, the size of the business; and b, our competitive business with our middle market business. And on the other hand, we’ve invested heavily to support the Global Banking business including investment banking and that business earned $2 billion after tax, and we’ve increased the commitments in that business internationally, as I said earlier from $30 billion round numbers after the crisis to almost to $100 billion today. So, we can do better and we’ll just keep pushing away at it.

I’m not sure what else to add. If you look at where we underperformed this quarter, it was in M&A and somewhat in leveraged finance. Our market share in M&A declined a bit this quarter, which is evident in the announced transactions over the last couple of quarters. Some of our clients were involved in deals that they didn’t win, or perhaps we weren’t selected in some of those transactions.

That’s extremely helpful color. So, I appreciate remarks from both of you. Just one follow-up for me and I’ll head back in the queue, on loan growth.

Yes. I think we’re still committed to doing that. You can see, as you referenced, Steven, in slide eight, you can see that commercial slowed down a little bit in the last section. But, the key, the consumer and the GWIM business continues to grow well. We expect to be in the mid single digits. The big debate is if the economy slowed down a little bit from the current growth rate next year, as many people projected, if it goes into recession, that changes the picture obviously. But, if it just slows down, remember, the economy that grew 2% plus or minus for many years, after the recovery settled in, you can see on slide eight, you can see that in earlier things, we grew loans in mid single digits. So, we’re comfortable in a 2% growth economy and we can continue to do that.

I had two questions. One, just on deposits. I know that you spent quite a bit of time going through on page seven the growth rates there. Could you give us a little bit of color around how you are driving that increase in deposit growth, given that your deposit yields are not the highest on the street? You’ve got a very efficient deposit franchise. So, I just wanted to dig into that, as well as on the Global Banking side, increase in deposits, would you deem those to be operating or non-operating? Just wondering.

On the Global Banking side, we are focused on growing our operating deposits. We are experiencing a transition from non-interest-bearing to interest-bearing deposits, but they remain operational. In terms of deposit growth across our franchise, we are managing to grow deposits with limited increases in the rates we pay. Specifically, we are raising deposit rates in GWIM and Global Banking, while the industry has not made significant increases in traditional consumer bank account rates. This can be attributed to the value that Bank of America provides to depositors, including transparency, convenience, safety, mobile and online banking, a nationwide network of financial centers, as well as rewards and advisory services.

And your branch expansions that you’re planning on doing over the next several years, that hasn’t materially kicked in yet. Is that correct?

It’s been material relative to the start to finish and we’ve crossed a $100 million branch for example in Denver within three years, which is very strong, but it’s not material to the $1.4 trillion deposit base or the $680 billion in consumer. So, it’s not contributing, it will over time, but right now, it’s marginally adding. Betsy, a couple things to think about. The amount of investment we’ve made in the global transaction services platform across the last eight or nine years have been over $2 billion. So, those deposits come from the ability to continue to provide better and better services to clients in an investment rate, and that’s the thing.

And those deposits are up 7% year-over-year. So, we’re seeing the growth.

Okay. So then, just my last question here is on the LCR ticked down very slightly from 122 to 120. And if the Global Banking is not driving that, what was driving the slight tick down that you had in LCR ratios this quarter?

I don't believe there are any significant changes apart from adjustments to our outflow assumptions and some model tweaks. We have a strong liquidity cushion at the highest level. In terms of managing liquidity, we are more cautious at the bank level, but overall, we have ample liquidity at the top level.

Hi. Good morning. Brian, you guys delivered on the expense numbers again this quarter, and the commitment to keep the expenses flat at $53.5 billion for two more years is impressive. I know I’ve asked you this before; I’d love to hear it again. You’ve come so far on improving efficiency already and you are doing a lot of investing, as you detailed on slide four. So, how you do all that, the modernization to build out the expansion, and then also keep expenses flat for two years?

Well, John, one of the interesting things to highlight, using the consumer example, is that if you evaluate the costs associated with producing deposits, meaning if you take all the costs from the consumer business and divide it by the deposit base, you'll notice that this has decreased by 152 basis points. This shows a slight improvement from the second quarter to the third quarter, showing a 3 basis point drop last year and a 7 basis point drop this year. This reflects all the initiatives we've discussed. There are slightly fewer branches now, transactions per branch are increasing, branch sales are also on the rise, along with digital sales. You can find all the statistics related to digitization on page 15, which illustrates the efforts we are implementing across the entire franchise.

Okay. And just a quick follow-up to that. I know you don’t have a formal goal on this metric, but you printed an efficiency ratio of 57% this quarter. If you continue to deliver that positive operating leverage into next year and 2020, which seems likely, is there any reason you shouldn’t aspire to get to that mid-50s over time on that metric?

We should keep pushing it down to that level. Yes.

Hi. Just to follow up to that last question. So, I know John, who asked the question, said, if you get better revenue growth, are you committing or do you expect to have higher revenues in 2019 and 2020?

Given the economy, if we have what are consistent with the economic projections of us and the rest of the people, sure.

Okay. So, flat expenses with higher revenues for the next two years. I guess, one reason that you just mentioned for that is digital banking. You have 26 million mobile banking users. What’s the total size of the market? What percent of the market do you have in mobile banking?

I’m not sure of the exact number right now, Mike. However, with around 130 to 140 million households and all the users, I believe we hold a significant share of it. We can work out that calculation, and I’ll have Lee follow up with you on that. I just don't have the information available at the moment.

That’d be great. And as far as the new markets, can you remind us what are your four new markets and the five new markets yet to come?

The four new markets that are now open are Denver, Minneapolis, Indianapolis, and Pittsburgh. Additionally, we have Cincinnati, Columbus, Lexington, and Cleveland, although I believe I'm missing one.

Out west?

I got Lexington. But anyway, we’ve got them listed somewhere here. I’ll send them to you.

Okay. So, why now? It seems like everyone is getting involved in the national digital banking competition at the same time. You’re not alone in this expansion. Your consumer efficiency ratio this quarter appears to be 46%, which might be your advantage. So, why are you expanding into these new markets now? Are you doing enough to leverage your advantage if you are indeed more efficient than others?

Mike, you need to consider the history of interstate banking. The reason we aren’t in these markets is due to a historical accident during acquisitions. The idea is that we already have customer bases in these markets, and we're establishing branch systems to align with those customer bases and our existing teams. For instance, in Denver, we had commercial banking, business banking, Merrill Lynch, and U.S. Trust. We then integrated branches, and in three years, we expect to see a branch generating $100 million. Looking at competitors' branch structures, they likely won’t achieve that for another 10 years. This gives us a competitive advantage through our brand, capabilities, and existing customer base, allowing us to deepen relationships that are already in place.

And just one other statistic for you, Mike, that may be helpful. Again, these are our customers who want us to be in these regions because they’re already there. We just don’t have a retail footprint. We have top three deposit market share in 24 out of the top 30 markets in the United States. So, this is about filling out those last six markets to get us in the top three.

And, last follow-up. Any potential changes in your marketing spend as you engage in this expansion?

We increased our marketing spend and our shareholder spend as part of sharing in the shareable side with the communities that benefit the tax reform. So, we increased it by $50 million. And on the marketing side, marketing is done differently in this traditional media spend. So, we basically want our customers to be able to answer the question, assess the question themselves, what do you want the power to do? And we’ll keep reminding them that we’re here to provide the services and capabilities they need so they can live their financial lives, and we’ll market that to them.

Maybe just a quick question on just sort of consumer spend on debit and credit cards, 7% growth felt good, but a little bit of a deceleration from the first half.

The question a little bit that you’re hearing debate, as you see some of the consumer spending numbers come up is they’re very strong. So, the third quarter this year, all spending including cash, all the ATMs, bill pay, everything, it was 8% plus over last year, and last year to the year before that, that number was around 5%. So, it’s still accelerating.

We are always considering earnings, capital, and liquidity when evaluating that portfolio. Upon closer inspection, given our cash, treasuries, and mortgage-backed securities, the duration isn't as long as one might expect.

Okay, great. Thanks.

Just one more thing by the way. I just want to emphasize for everybody who doesn’t know. We don’t take risk in that portfolio.

I was wondering if you could talk about the outlook for net interest income dollars, just given a little bit of a backup in long rates. You just commented that it takes a lot of work at sell-through, but obviously that’s an incremental positive. The continued steady march up in short-term rates should continue to be a positive. It sounds like you are optimistic about loans continue to grow. So, maybe just give us a little outlook on the net interest income dollars the next few quarters or however you want to frame it.

Sure. Look, we are optimistic. In 4Q, we’re going to benefit from the September rate hike. We should also benefit from loan and deposit growth. I think, the only real question is how much of these benefits are going to be offset by rate increases on deposits.

And then, just to clarify, I think you said net interest income growth in 4Q is similar to 3Q. Did you mean the growth rate linked quarter would be similar or the absolute dollar is similar?

I would think about it. As we’ve started Q4 and it's early, the net interest income growth we’re experiencing feels a lot like Q3 in terms of the movement in rates paid so far.

Okay. And then, just a little bit related, as we think about the NIM percentage, obviously a nice increase this quarter. I think, you’re past some of the drags as we think year-over-year in terms of the international card business; it was dragging in the first half of the year. Should that trend up as well?

Yes. I think, you hit all the points. In 4Q, given the September rate hike, again, I would expect net interest yield or net interest margin, whatever you want to call it, to edge up in the fourth quarter.

I just want to follow up on some of the comments you made on loan growth. And I hear you on high competition, good capital markets, non-bank lenders, corporates flush with cash. What I didn’t hear is anything about, from the competition, on aggressive pricing or loosening of terms. So, I wondered if you could address, if you’re seeing that, and particularly from the non-bank lending side because there has been a lot more talk about that lately. Thanks.

Consistent with recent discussions, competition from non-banks is significant, and the structures that have been widely reported have indeed gained traction. We aim to position ourselves in the middle of the market and intend to continue that strategy.

Does that mean I understand your responsible growth approach and I think your shareholders will appreciate it over time. But, do you notice any weaknesses in this approach? Are you hesitant to pursue certain returns on investment, or do you believe there is some irresponsible growth occurring?

Look, I think what we would emphasize is given the strength of our platform, given the bankers that we’re adding, given our relationships globally, we should be able to grow loans the way we’ve been talking about, even with these forces, even with the non-banks, even with whatever you’re seeing out there.

So, we can do better and we’ll just keep pushing away at it. It’s a $1 billion and change of revenue. A lot of it was driven by the M&A environment where we didn’t get our fair share. But, the key is to maintain our dominance in debt underwriting and things like that which we’ve got to make sure we do.

Hi. Good morning. Can you quantify the impact of the lower provisions for representations and warranties in the sale of the consumer real estate portfolio in all others?

No, I wouldn’t chalk it up to all the reps and warranties. Reps and warranties were down a little this quarter. But, if you look at net income, it bounces around quite a bit every quarter. I would point out, by the way, if you look at that, it’s been gradually declining.

I'm trying to clarify the situation. Although the figures fluctuate, I aim to eliminate some of the distractions and get a clearer understanding of where we might expect that line to trend.

CECL. So, we’re not at the point where we’re going to provide an estimate on the impacts. We’ve made a lot of progress on our efforts towards adoption. However, a number of things need to be finalized really before we can disclose the impacts. I would point out, by the way that we’re not overly concerned about those impacts and it’s certainly not going to change how we serve our clients in the future.

I want to talk first about asset yields. And earning asset yields were up 11 basis points. There looks to be some noise in other earning assets this particular quarter. It was up 55 basis points. So, just curious what was driving that big increase this particular quarter.

Other earning assets was up 55 basis points. Do you think it was the margin?

Yes.

Okay. And then, in consumer loans, you’ve been going up about 6 basis points per quarter over the last three quarters leading up to this quarter; now, it was up 16 basis points. So, it looked like there was another step up in consumer loans, which I thought may have been maybe something in the consumer loan portfolio as well.

I don’t think there’s anything unusual in the consumer loan portfolio that’s driving those results. It’s just a mix every quarter of what we are growing versus fixed and floating rates or the effects of the rates.

Which is good in sense that earning asset yields are moving up faster, which is what we’d expect to happen at this particular part of the interest rate cycle, as you’re beginning to reprice some of the longer-term assets as well as the short-term assets.

Agreed.

Hi, Brian. How are you?

Good.

You have worked very diligently with your team since 2010, bringing Bank of America to this level of profitability that you reported today, 123 basis points on assets and an ROE of 11%. What do you think about your balance sheet mix? How much higher can you go, whether it’s ROA or ROE? Is this a bank that can achieve 140 basis points on assets, or is that too optimistic?

I would say, Gerard, you’ve got to be careful because the mix of the business we have versus what people could have been familiar with at different times in our past is with the markets business and the way that business works in terms of ROA and things, but the reality is the team has done a great job of getting this Company back to an earnings level. And we expect to continue to grow that, and we continue to expect to reduce the share count, 1.4 billion reduction since we started.

Very good. Following up on your earlier comment, national interstate banking has significantly changed the landscape for banks. Your deposit market share is above the 10% threshold that restricts a bank from pursuing depository acquisitions. It’s clear you are focusing on an organic growth strategy as you mentioned. Looking ahead, if depository acquisitions are off the table, can we expect your return of excess capital to remain consistently between 70% and 80% of earnings indefinitely?

Right now, between the dividends and share repurchases, $6.5 billion this quarter on earnings of $7.2 billion, so it’s pushing to 100%. We have excess capital under any standard on top of that. So, we’ve got to adjust that as we continue to figure out what the future of the CCAR rules are and stuff like that. But yes, you should expect that we can return it all. And if we ever need to retain it, any portion of it is going to be in conjunction with earnings, which are accretive to the returns in the balance sheet.

Thank you, everyone, for your time and attention this morning. We continue to operate in a good business environment led by the consumer spending we discussed. Commercial clients continue to have good activity. We continue to perform well in this environment. And we’re getting more than our fair share of business. And to do that, we’ve managed expenses well, drove operating leverage 700 basis points for the quarter. When you think about all this, you have to think back to what we’ve been talking to you each quarter, which is we are here to drive responsible growth, and this quarter shows another quarter of that with record earnings across the franchise. Thank you.