Revenue was up for the three months ended June 30. Expenses were down. And Bank of America earned more money before taxes than it has since the financial crisis.
Take it from someone who has followed Bank of America closely for four years: It was an impressive performance.
Bank of America adopts a new tone at the top
Two things in particular struck me as I listened to the bank's conference call with analysts. The first was the change in management's tone and, specifically, the focus of CEO Brian Moynihan's comments.
On previous calls, Moynihan has saved most of his prepared remarks for discussing expense control and cycling through the standard list of industry benchmarks -- such as credit quality, capital levels, and the growth of online and mobile banking.
There's no question that these are important. If there's one thing Bank of America must do to compete with Wells Fargo and JPMorgan Chase, it's get expenses under control. Last year, Bank of America spent 89.2% of its net revenue to operate the business, leaving only 10.8% to cover loan loss provisions, pay taxes, and distribute to shareholders through dividends and share buybacks. By contrast, 35% of JPMorgan's net revenue was left over after operating expenses, and 41% of Wells Fargo's top line emerged free and clear of costs.
Given those circumstances, it was remarkable that Moynihan dedicated only three sentences of his prepared remarks to expenses:
On the expense side, we told you that we achieved [Project New BAC's] cost savings back in the third quarter of last year. However we didn't give up on our focus on expenses, and you can see those in the results. It's the lowest non-litigation expense base since 2008.
The reason Moynihan changed his script may be that Bank of America seems to have finally reduced its bloated expense base to a manageable level. Its efficiency ratio in the second quarter was 62.5%, well within reach of the sub-60% level of the country's most efficient banks.
Banks of America's 2011 expense initiative, Project New BAC, reduced annual expenses by $8 billion. The majority of outstanding legal liabilities are now in the rearview mirror (more on that in a moment). And the headcount at Bank of America's unit tasked with disposing of toxic and noncore assets has fallen from its peak of 41,800 full-time employees in the second quarter of 2012 to 12,600 today.
Thus, rather than talking about expenses, Moynihan pivoted toward a discussion of increasing sales -- or, as he put it, "invest[ing] in the future" of Bank of America:
Just to mention a few of these investments, we added sales specialists in our financial centers, up 3% versus last year. We added 3% to our financial advisors since last year, 4% to our commercial and business bankers. We've opened new financial centers in new markets that we previously didn't have coverage and we continue to upgrade those in other markets.
In addition, we continue to invest in young new talent in our company. We hired a record number of teammates from college, over 1,200, and we have our intern program to over 1,800 this summer. And we continue to invest as we have said in technology, so that was $3 billion we spent this year to continue to improve and drive our products and our capabilities in the company.
Not to belabor the point, but this represents a dramatic shift in Moynihan's tone over the course of his tumultuous five-year tenure.
Bank of America's legal troubles may finally be over
The second thing that caught my attention concerned Bank of America's estimate of its outstanding legal liabilities. While large corporations will always be in and out of court, none has ever experienced the cumulative degree of legal damage that Bank of America has since 2008.
By my count, B of A has incurred upwards of $100 billion worth of legal fines and settlements over the past seven years. The lion's share of these charges relates to Countrywide Financial's sale of faulty mortgage-backed securities to institutional investors in the years before Bank of America acquired the mortgage-originator-cum-criminal-enterprise on the eve of the financial crisis.
Not unlike televisions sold by an electronics retailer, financial products such as residential mortgages that are sold to institutional investors come with representations and warranties that guarantee the integrity of the underlying product. If the product is faulty, then a buyer can, in essence, return it to the seller by making a representation and warranty claim just as you would with a faulty refrigerator.
This particular type of claim has cost Bank of America dearly. To name just a few of its biggest rep-and-warranty settlements:
- In August 2014, Bank of America agreed to a $16.65 billion settlement with government regulators.
- In March 2014, the bank entered into a $9.5 billion settlement with the Federal Housing Finance Agency.
- In January 2013, it paid $11.2 billion in various forms of relief to Fannie Mae.
- In June 2011, Bank of America reached an $8.5 billion settlement with 22 private institutional investors.
Although you'd be excused for thinking that claims like these must be coming to an end -- after all, the housing bubble burst nearly a decade ago -- the reality is that they've continued to haunt Bank of America into the present year. From April 2014 through March 2015, the bank received more than $10 billion in new rep-and-warranty claims. Over the same period, Bank of America earned only $8.5 billion in net income.
The good news for Bank of America's shareholders is that this may have finally come to a halt. At the very least, the magnitude of the rep-and-warranty claims is no longer oppressive. A ruling by New York's highest court during the quarter appears to bar all claims brought more than six years after the date the representations and warranties were made. As CFO Bruce Thompson explained:
This quarter there was a closely watched case in New York's highest court, which confirmed that New York's six-year statute of limitation on filing rep-and-warrant claims begins to run at the time the reps and warranties are made and not at some later point in time. Based on our review of the relevant documents we believe the vast majority of the bank's remaining rep-and-warranty obligations are governed by New York law.
The net result is that Bank of America was able to reduce the amount of money it sets aside to cover rep-and-warranty claims by $7.6 billion. Furthermore, while the bank previously estimated that it could face $4 billion in losses above its rep-and-warranty provisions, the ruling led Bank of America to cut this projection in half. It now expects the total range of possible losses to be "up to $2 billion" over existing accruals as of June 20.
To say that this removes a dark cloud of uncertainty from over Bank of America's head would be an understatement, as concerns about ongoing legal losses have almost certainly played into the fact that its shares, until this week anyway, traded for a roughly 20% discount to their book value.
At the end of the day, in turn, while it may be premature for Bank of America to claim complete victory over the consequences of its past mistakes, there is a growing chorus of evidence suggesting that it may have done just that.