BANK OF AMERICA Investment Category: Income Sector: FINANCIAL Fixed Income Research Evan Marks, CFA December 11, 2017 Company Overview Bank of America is the second-largest U.S. bank by assets at roughly $2.2 trillion in assets. The company offers a complete range of financial services and has roughly 47 million consumers and business relationships. Bank of America conducts business in 35 countries. Primary Subsidiaries Include Countrywide LaSalle NationsBank Merrill Lynch MBNA Parent Credit Ratings Moody's... A3/Stable S&P... A-/Stable Fitch... A/Stable Financial Data Debt/Capital... 46% Total Debt/Equity... 197% Earnings to Fixed Charges... 3.1x U.S. Recommended Corporate Bond Sector Weightings Financial (30%- 45%) Utilities (10%- 25%) Industrial (35%- 55%) Appropriate for Income Recommendation We consider bonds of Bank of America (and its subsidiaries) to be an appropriate holding for investors seeking Income within a well-diversified portfolio. Edward Jones Credit Strength Assessment Investment Summary We believe Bank of America's financial position has improved, and the underlying strength of its businesses should allow the company to continue to make timely interest and principal payments on its outstanding debt obligations. Bank of America's operating performance has trailed peers over the last several years, but with the resolution of the majority of its legacy legal issues and increased focus on its core businesses, we expect Bank of America's financial condition should continue to improve. In our view, Bank of America remains a sound corporate credit. Bond Strengths We believe Bank of America has strong franchises with leading market positions that have the potential to generate significant profits. Bank of America has experienced solid improvement in overall asset quality and capital levels and, in our view, possesses the potential to benefit from additional cost-cutting efforts in a more meaningful way than peers. Bank of America's legal costs appear to be primarily behind it, and this should allow Bank of America's financial position to continue to improve. Bond Weaknesses Bank of America has a large capital-markets business which is complex and has the potential for wide swings in revenue and profitability. Bank of America's financial position has improved but remains modestly weaker than its large U.S. banking peers. U.S. Recommended Bond Ladder Short-term (up to 5 years) 30%- 40% Intermediate-term (6-15 years) 40%- 50% Long-term (16+ years) 15%- 25% Please see important disclosures and certification on page 4 of the report. Page 1 of 5
Recent News and Analysis 12/4/17: Fixed Income Research has increased its credit strength assessment of Bank of America to Above Average from Average. Bank of America has worked through many of its legacy legal issues that masked its strong position across its business segments and delayed its ability to achieve more consistent business results. Over the past few years, fundamental results have improved, allowing the firm to build more capital to a point where its capital buffer is now only modestly below peers. A renewed focus on high-quality underwriting has also led to loan charge-off ratios falling significantly to levels below its closest mega-bank peers. These factors, along with more remaining levers than peers to reduce expenses and with its above-average sensitivity to rising rates, position the firm well to continue to produce solid results in a variety of potential operating environments. As a result, we believe Bank of America has above-average credit strength, and we continue to consider bonds of Bank of America to be an appropriate holding for investors who seek income within a well-diversified portfolio. 10/13/17: Bank of America reported third-quarter net income of $5.6 billion, modestly ahead of analyst expectations. A largerthan-expected decline in operating expenses and lower-thananticipated provisions for future loan losses drove the upside earnings surprise. Bank of America also reported that its Basel III Tier 1 common ratio, a regulatory measure of financial strength, increased to 11.9% during the quarter compared with 11.6% in second-quarter 2017. From a bondholder's perspective Bank of America produced a mixed quarter overall. Revenue growth was slightly weaker than anticipated due to larger-than-expected declines in mortgage-, investment- and brokerage-related fee income. The firm's net interest margin also expanded less than analysts had expected as total deposit-related expenses accelerated sequentially, driven by higher CD and money market rates. Loan growth was roughly 1% sequentially, modestly weaker than peers for the second straight quarter. Expense management was really the highlight of the quarter because the firm drove expenses down 4% sequentially. Credit quality showed modest improvement, primarily driven by improvements in the firm's residential mortgage and credit card portfolios. Bank of America's financial position remained solid during the quarter as the bank improved capital levels. We consider bonds of Bank of America and its subsidiaries to be an appropriate holding for clients seeking income as a portion of a diversified portfolio. Company Outlook Majority of Legacy Legal Issues Addressed Since 2008, Bank of America has agreed to pay in excess of $90 billion to settle a number of legal disputes primarily related to its mortgage and foreclosure practices. While we would note that it is difficult to predict potential future litigation, we believe that Bank of America has now addressed the majority of its legal issues and should see legal-related expenses decrease. Improving Capital Position One consequence of the financial crisis is an increased regulatory burden. Regulations proposed and implemented have touched on several topics, which include limiting lines of business in which banks can operate, raising capital requirements, undergoing financial stress tests, and even creating plans for an orderly wind-down in the event of a bank failure. Executives at financial institutions have actively worked to position their organizations to meet and in many cases exceed the required minimum levels prescribed by various regulations well ahead of their formal application. Bank of America is no exception. However, the firm has seen its capital base improve more slowly than peers due in part to larger legal settlements. Reduced legalrelated costs should allow capital to build faster at the firm. Given the resolution of the majority of outstanding legal concerns and the improving fundamental performance at the bank, we expect Bank of America's capital position will continue to improve over the next few years. While the increased regulatory burden has made it more difficult for the banks to earn a return on capital, we believe new regulations are generally positive for bondholders because they have reduced overall risk. Basel III Common Equity Tier 1 Ratio Basel III CET1 Ratio 13.0% 12.0% 11.0% 10.0% 9.0% 8.0% 7.0% 6.0% Q409 Q110 Q210 Q310 Q410 Q111 Q211 Q311 Q411 Q112 Q212 Q312 Q412 Q213 Q413 Q214 Q414 Q215 Q415 Q216 Q416 Q217 CET1 Ratio Required Minimum Ratio Diversified Revenue Base Is Beneficial in the Current Interest Rate Environment The current low interest rate environment has compressed the spread that banks are able to generate from traditional borrowing and lending activities. We expect rates to remain lower for longer, and we believe that banks with strong fee-generating business are better positioned to weather this difficult environment. Bank of America generates nearly half of its total revenue from feerelated businesses and has strong positions in consumer lending, capital markets and wealth management. Leading Wealth-Management Position a Strength Through its Merrill Lynch and U.S. Trust platforms, Bank of America is a wealth-management industry leader with top market share positioning in client assets, deposits, loans and personal trust assets under management. Bank of America s wealth-management offerings span the full spectrum of potential Page 2 of 5
clientele. Wealth management accounts for roughly a fifth of total income and generates the second-highest average return on allocated capital of any business segment at Bank of America. Beyond generating solid returns, there also tends to be less variability in the segment's performance given that nearly 77% of revenue comes in the form of recurring fee-based and banking activities. GlobalWealth and Investment Management (GWIM) Revenue as a % of Total Revenue GWIM Return on Average Allocated Capital vs. Median BAC Return on Average Allocated Capital of debt led to solid growth in the early 2000s, but the environment changed with the onset of the financial crisis in the second half of 2007. Falling asset values and rising loan losses led to a global reduction in the availability of loans and a sudden increase in the cost of obtaining loans. The U.S. government was forced to intervene and invest in many large financial services companies to bolster their financial positions. All of the large financial services companies repaid their government loans a few years ago, but there are some lasting effects of this difficult period that affect the banking sector today. 25% 35% % of Total Revenue 20% 15% 10% 5% 0% GWIM now accounts for a much larger percentage of total revenue 2009 2010 2011 2012 2013 2014 2015 2016 Return on Average Allocated Capital (ROAAC) % 30% 25% 20% 15% 10% 5% 0% GWIM ROAAC Median ROAAC Declining Leverage, Solid Financial Position Overall Bank of America has reduced leverage significantly, which, along with the need to hold more equity capital to meet required regulatory minimums, has led to an improving financial position. The amount of total debt, including federal funds purchased, as a percentage of total equity as of December 31, 2016, was 197%, well below the median level of 338% during the last 15 years. We expect Bank of America's solid financial position will continue to modestly improve in the near term, and we believe that Bank of America is well-positioned to benefit from improved economic growth along with the potential for rising interest rates. Government regulation of the banking sector increased dramatically following the financial crisis, and additional regulatory measures continue to be developed. While banks have moved aggressively to meet or exceed the new standards, the need to consistently grow their capital positions has negatively affected returns. We do not expect regulatory pressure to diminish soon, which we believe will lead to the existence of excess capital in the banking system for many years to come. The financial crisis also caused central banks around the world to implement aggressive and at times unprecedented measures. These efforts have contributed in part to the very low interest rate environment in the market today. Banks have experienced a significant decline in the spread between the amount of interest earned when extending credit and the amount of interest paid to fund this activity. Declining spreads negatively affect profitability. While interest rates have increased following the results of the U.S. presidential election, we continue to believe the intermediate path for interest rates remains uncertain. We also expect the sector will experience a near-term headwind from an increase in credit-related costs from the current near historical low levels. Over the long term, we expect a growing economy and an aging population will increase demand for the services provided by the financial services sector. Total Debt and Fed Funds Purchased as a % of Total Equity Total Debt and Fed Funds Purchased as a % of Total Equity 450% 400% 350% 300% 250% 200% 150% BAC's total debt-to-equity ratio has improved signficantly as the firm has reduceddebt outstanding and has been required to hold higher levels of equity Debtand Fed Funds Purchased/Equity Long-term Median Q109 Q209 Q309 Q409 Q110 Q210 Q310 Q410 Q111 Q211 Q311 Q411 Q112 Q212 Q312 Q412 Q213 Q413 Q214 Q414 Q215 Q415 Q216 Q416 Q217 Financial Strength Bank of America s capital position remains above minimum regulatory standards. Bank of America's financial position has improved, and we view it as adequate to support its current and future debt obligations. Despite the challenging operating environment, we believe continued cost-cutting efforts and a modestly improving economy should lead to further improvement in the financial position of Bank of America. Edward Jones Credit Strength Assessment We believe Bank of America's credit strength assessment is above average. This is due to its diversified business model, solid capital levels, and improved risk management, which help to offset its exposure to riskier revenue sources. Industry Outlook The financial services sector can be described as highly competitive and mature. Rising asset values, looser lending standards, the invention of new products, and the increased use Page 3 of 5
Required Research Disclosures December 11, 2017 BUY HOLD SELL Corporate Credits 0% 89% 11% Investment Banking Services 0% 22% 0% The table lists the percent of corporate credits we follow globally in each of the equivalent rating categories. We do not assign a "Buy" rating to any corporate credits. Investment banking services indicate the percentage of those subject companies that have been investment banking clients within the last 12 months. Appropriate for Income Appropriate for Aggressive Income Sell FYI Appropriate for Income We consider bonds Appropriate for Aggressive Income We consider Sell We recommend investors sell these bonds. We FYI - For informational purposes only; to be an appropriate holding for investors seeking Income within a well-diversified portfolio. Our time horizon is 3-5 years. bonds appropriate only as a small Aggressive Income portion within a well-diversified portfolio. Bonds within this category are riskier, with a higher possibility of loss due to default, than bonds classified as Income. Our time horizon is 3-5 years. believe these bonds are no longer an appropriate fixedincome holding because, in our opinion, they offer an factual, no opinion. unattractive risk/reward scenario at current prices. Our time horizon is 3-5 years. Initiated Coverage (Appropriate for Income) 12/11/09 Analyst Certification I certify that the views expressed in this research report accurately reflect my personal views about the subject securities and issuers; and no part of my compensation was, is, or will be directly or indirectly related to the specific recommendations or views contained in the research report. Evan Marks, CFA Edward Jones has received compensation from this company for investment banking services within the last twelve months. Edward Jones has provided investment banking services for this company within the past twelve months. 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When investing in issuers incorporated outside your own country of residence, you should consider all other material risks such as currency risk, political risk, liquidity risk and accounting rules differences, which can adversely affect the value of your investment. Please consult your Financial Advisor for more information. Edward Jones Credit Strength Assessment: Low Our opinion is these credits are of low financial quality. We believe these credits are the most likely to default and experience the most financial hardship. Below Average Our opinion is these credits are of below-average financial quality. We believe these credits are more likely to default or experience financial hardship than the average. Average Our opinion is these credits are of average financial quality. We believe these credits have a low probability of default or low chance of experiencing financial hardship. Above Average Our opinion is these credits are of above-average financial quality. We believe these credits are less likely to default or experience financial hardship than the average. High Our opinion is these credits are of the highest financial quality. We believe these credits have the lowest probability of default and will experience the least financial hardship. Ratings from Standard & Poor's ("S&P"), Moody's and Fitch may be shown for certain securities. S&P requires we inform you: (1) Ratings are NOT recommendations to buy, hold, sell or make any investment decisions and DO NOT address suitability or future performance; (2) S&P DOES NOT Page 4 of 5
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