DBRS Ratings Unchanged After Q3 Earnings of BAC; Senior at A

DBRS has today commented on the Q3 2009 operating performance and earnings of Bank of America Corporation (Bank of America or the Company). DBRS sees Bank of America’s ratings as unaffected by Q3 2009 results. The Company’s “A” Issuer & Senior Debt rating reflects its status as a Critically Important Banking organization (CIB) in the United States. CIBs benefit from DBRS’s floor rating of “A” for bank holding companies and A (high) for banks with short-term ratings of R-1 (middle). Given the nature of the rating floor, these ratings have Stable trends.

Continued elevated credit costs, the $2.5 billion (pre-tax) cost of tightening credit spreads on Company debt & derivatives and the $402 million (pre-tax) charge for terminating the U.S. government asset guarantee were the primary drivers for a quarterly loss of $1.0 billion ($2.2 billion after payment of preferred stock dividends). The loss is the second in the past four quarters with the previous being the fourth quarter of 2008. DBRS believes that the combined challenges of continued high credit costs, business integrations, supervisory activity, management continuity, and talent retention will constrain the Company’s performance and earnings in the near-term.

Business results were mixed as some positive performance gains were somewhat offset by steep credit costs and one-time charges. Similar to the first two quarters of the year, results reflected a significant contribution from Merrill Lynch’s investment banking businesses, with investment banking fees decreasing $392 million from Q2 2009 (due to some seasonality) but still strong at $1.25 billion as both equity and fixed income underwriting experienced strong growth. Mortgage banking fees (consolidated) at $1,298 million were down 49% from $2,527 million in the second quarter and were 22% off the year-ago level. First mortgage production, although off 13% from the prior quarter, was still strong at almost $96 billion, but a $519 million loss from MSR hedging muted consolidated mortgage income. Managed net interest yield compressed 6 basis points (bps) as average managed earnings assets declined 1.3% due to weaker loan demand and the Company’s continued de-leveraging strategy.

Positively, market disruption charges continued to show improvement with an actual net gain of $200 million in the quarter compared to prior charges of $1.3 billion charge in the second quarter, $1.7 billion in the first quarter, and $4.6 billion in Q4 2008. Also, the drive to reduce market-related risk exposures continued. In the quarter, the Company reduced its super senior CDO, credit default swap with monoline financial guarantors, leveraged loan and capital market commercial mortgage exposures. Liquidity exposure to off-balance sheet special purpose entities was also materially reduced.

Credit quality deterioration was broad-based across portfolios, but generally the rate of deterioration was less than in the previous quarters and consumer near-term delinquencies may be moderating. DBRS expects credit trends to continue to produce elevated credit costs as the impact of a recessionary economy and increasing unemployment weigh on consumers and businesses.

Nonperforming assets were up (but less sharply than the prior quarter), rising $2.84 billion from Q2 2009 to $33.8 billion (or 3.72% of total loans, leases and REO) at September 30, 2009 and 90 day past dues loans rose 18.6% in the quarter. Positively, credit card 30 day past dues declined for the second consecutive quarter.

Company-wide net charge-offs (NCO’s) were $9.6 billion for the second quarter (4.13% of average loans), a 10.6% increase from Q2 2009 (but less than the 25% increase between the first and second quarter) with most categories reflecting substantial increases in charge-offs. Credit card managed losses increased 8.5% over the quarter to $5,477 million as losses climbed to 12.90% from 11.73%, a much slower pace than from the first to second quarter. Stressed consumer geographies, California and Florida in particular, continue to produce disproportional amounts of losses as do high LTV and 2006-2007 vintage loans. The Company prudently added substantial reserves with a quarterly provision that was $2.1 billion in excess of NCOs (but much less than the $4.7 billion last quarter). The largest reserve addition was $1.3 billion added for higher expected frequency and severity in the Countrywide purchased impaired portfolio. In terms of coverage, Bank of America’s $35.8 billion allowance for loan losses (excluding the reserve for unfunded lending commitments) was 1.12x nonperforming assets (including foreclosed properties) and 3.95% of total loans and leases.

In DBRS’s opinion, weakness in corporate governance is evident given the unexpected announcement of Ken Lewis’ retirement effective at year’s end that resulted in a Board of Director’s rush to name a replacement. The inability to implement a succession plan in short order is indeed surprising and disappointing for a Company of Bank of America’s size and influence. Moreover, DBRS remains concerned about the Company’s ongoing legal struggles which may distract management and lessen its ability to maintain and attract management talent.

Bank of America’s capital ratios continue to rise with Tier 1 increasing 53 bps in the quarter to 12.46% and Tier 1 common up 35 bps to 7.25%, both providing substantial cushions above regulatory requirements (but also incorporate $45 billion in TARP capital). The Company’s tangible common equity ratio also further improved 15 bps over the quarter to 4.82% which represents a marked improvement from the low of 2.75% in Q3 2008 and moving closer to the range of its similarly rated peers. Liquidity and funding remained sound as the Company benefits from various Fed liquidity facilities and strong deposit franchises within its diverse businesses. DBRS notes, however, that Bank of America exited TLGP and has executed non-FDIC guaranteed debt offerings in multiple currencies over the past few quarters. Moreover, the Company continues to grow its deposit base with total average deposits rising 1.5% over the quarter (6.0% annualized) with 4.5% (FTE) growth in noninterest bearing deposits. This performance is especially noteworthy given the runoff of legacy high-yield Countrywide in the quarter.

Bank of America’s ratings are underpinned by a strong franchise with top market positions in deposits, mortgage lending, small and middle market business lending and credit cards. With the addition of Merrill Lynch, the Company now also has prominent market positions in investment banking, various capital markets businesses and one of the largest Wealth Management businesses in the world.

Note:
All figures are in U.S. dollars unless otherwise noted.

The applicable methodologies are Rating Banks and Bank Holding Companies Operating in the United States and Enhanced Methodology for Bank Ratings – Intrinsic and Support Assessments, which can be found on our website under Methodologies.

This is a Corporate (Financial Institutions) rating.