Bank of America Corporation (BAC) Earnings Call Transcript & Summary

I see. Historically, when we go back into different downturns, construction lending, leverage loans, LBOs or highly leveraged transactions, as they used to be called, tended to have the highest concentrations of credit loss. When you look at the portfolio today and you look out, assuming we don't go into a double-digit downturn, what do you think -- what loan categories may show up as the ones that give the highest levels of credit losses? Again relative to past cycles, there'll be less, we understand that, but relative to where we were at the beginning of the year?

Sure. For the most part, we'll just have to wait and see. But to name a few, I would say that unsecured credit card is always the issue at the end of the day. And we should see the largest percentage of losses as a percent of everybody's card portfolio, just by the nature of that product, which, by the way, is why we've got an 11% reserve ratio. . You already mentioned it, but I'll mention it again, CRE also may be an area where loss rates may be elevated given COVID's potential impact on that sector. Again, we're very well positioned in CRE with a much more balanced portfolio than we had in the last downturn and a much lower concentration in CRE relative to our peers. We've got about $63 billion of CRE outstanding and that's only 7% of total loans and less than 25% of our total equity. And if you look at those 2 percentages relative to other industry participants, you'll see that's quite low compared to the industry. And 90% of these loans are either secured by collateral or investment grade. And as I said before, the portfolio is regionally diverse. So I mean we feel really good about where we are. But if you're looking for sectors where we think you're going to see it across the industry, I would stay focused on credit card and CRE.

Yes. No doubt. The conference -- the title of our conference this year is How Will Banks Come Back: The Structural Challenge of Low Interest Rates for the Foreseeable Future. Chairman Powell, as you know, has stated that he wants to keep this rate environment, rates being this low, through the end of 2023. And if the 10-year government bond yield stays in this area, let's call it, 60 to 90 basis points, what are some of the strategies that you folks are focusing on to counteract that negative effect of a very low rate environment and a flatter yield curve?

Yes. So look, that kind of boils down to asset sensitivity, or for us, I like to use the words liability insensitivity, which really is driven by the quality and amount of our deposits, particularly our $870 billion in consumer deposits, half of which is in checking accounts. The bottom line is, in a low rate environment, these deposits and their associated relationships are extremely valuable, but just don't produce as much NII as when rates are higher. So in terms of strategies, we can make up for some of that with disciplined deposit pricing, and I think you see that we're doing that. But the best driver is improvement in market share across all our relationships, products and businesses. I alluded to this earlier, adding new customers and deepening with existing customers, that's really the key in this low rate environment: increasing referrals; growing deposits; growing loans; adding new households in GWIM; adding new credit cards and auto loans and mortgages, we touched upon that a little bit earlier; increasing market share in Treasury Services and Investment Banking and sales and trading. We think we have the leading market position, leading products and capabilities to do that. And in fact, we've been growing market share for years. And in a low rate environment, the competitiveness of many of our products only increases. So coming back to asset sensitivity, we're comfortable with our asset sensitivity and how we balance the trade-off across earnings, capital liquidity with respect to that sensitivity. As we said on our 3Q earnings call, we believe the third quarter will be the low for NII going forward, at least for us. And as far as some of the things we're doing specifically to address NII, we discussed in the call the redeployment of some excess cash into securities, which is, on a blended basis, we're getting about 100 basis points more than we otherwise would have if we had to get the Fed or overnight repo. So we'll see how all that plays out in the fourth quarter. There wasn't a lot of impact in third quarter, but it should help in the fourth quarter.

Very good. Speaking about -- and just as a reminder to the participants, if you do want to ask a question, we'll try to get to them. [Operator Instructions] Paul, getting back to you, you mentioned the spreads of what you're earning on the blend of securities. When do you see the yields in the securities portfolio being equivalent to what you can obtain in reinvestment of the cash flows that come off every quarter, the payments? How far -- what kind of differential is there between those 2 rates? And when do you think they may equal one another? I'm assuming they're not equal today.

No. They're not equal. And I don't know when they're going to be equal. That really depends on what happens with the yield curve, particularly on the long end. If you look at our securities portfolio, certainly, the current low rate environment has increased customer refinancings. And so we're seeing about $25 billion, $30 billion of paydowns and maturities each quarter in our securities portfolio. And if you look at the new purchases, they are about 30 to 40 basis points lower than what's running off on average. So again, this gets back to this notion of, well, how do you counteract that, you counteract it by growing market share across your other products, including deposits and loans, but importantly, all the other things we do for customers around the world.

Very good. Moving to the deposit side of the balance sheet, you and your peers have seen spectacular deposit growth this year. Obviously, the government programs, the Federal Reserve's activities are contributing to that, the consumers and your business customers building up their own liquidity. When you look at the balance sheet, when do you see -- or maybe not, when can we see these deposits maybe being utilized by businesses rather than keeping the liquidity at the level they're at, they start to reinvest in their own business, consumers start to use some of their excess liquidity for consumer spending? Any thoughts on when those trends could start to materialize and use up some of those excess deposits?

Well, that's an interesting question. I can come at it from a lot of different perspectives. The -- when somebody -- if the question is, when are we going to see deposit levels in this country go down, I think the answer to that is they're not going to go down because the only reason they would go down is if the money supply or the multiplier deflates materially. So -- and I don't think that, that's going to be shrinking the money supply for some time. And I think the multiplier effect is only going to improve from here as the economy grinds forward. If somebody lowers -- if somebody takes their money out of deposit account in our Consumer business and they buy something, it just goes into a corporate account, which we have a huge relationship or market share in. So deposits can move around with activity. That's what we want to see. We want to see more activity and more lending so that we can increase -- that's what increases the deposit base in size, and we'll get our fair share of that. And so I don't think deposits are going to shrink anytime soon, but you may see deposits go down in a consumer account but go up in a corporate account or it's all in the system somewhere, and we've got a significant market share of that system on both the Corporate and Consumer side. So unless these deposits all go to international banks overseas, we're going to get our fair share. And even then, we've got a lot of that market share as well.

Very, very good. Moving over to the P&L for a moment. Bank of America has been able to show everyone and prove that -- and build up your credibility on controlling operating expenses. Can you share with us what you think is an appropriate maybe run rate for expenses or how you're looking at expenses through the remainder of the year and into next year?

Sure. So let me just remind everybody kind of what we said on the call and then -- with respect to the third quarter and the fourth quarter and give you a sense of where we think our run rate is. So in the third quarter, we built some litigation reserves. That was about $600 million for some older litigation matters. The rest of the increase in the quarter-over-quarter in the third quarter was split between higher COVID-related costs and our merchant processing expense, which are not really higher but just accounted for differently for the first time in the third quarter now that our JV has gone away with respect to merchant processing. If you then look at the fourth quarter, we don't expect to have the litigation costs you saw in the third quarter. And we also don't expect to have expenses from processing really unprecedented levels of state unemployment insurance, which were very high in the third quarter. So we would expect expenses to decline in 4Q back down to roughly around the $13.7 billion level. And that $13.7 billion level will still have a few hundred million of net COVID costs in it, which will come down over the course of 2021. So gradually, we're moving back towards a level that approaches our pre-COVID run rate plus the merchant processing expense, which, again, is just a change in accounting. That would get you to sort of the low $54 billion range on an annual basis. And remember, you have to factor in -- I am factoring in, but you have to factor in about -- roughly $400 million in elevated Q1 payroll tax that we pay each year. But that number will obviously be a little higher next year since the COVID costs come out throughout the year depending on the pace as we move through this pandemic.

Well, you mentioned the COVID costs, a couple of hundred million, I think you said in the quarter. What do you think the annual amount is about? And is it primarily coming from personnel costs addressing the COVID issues? Or what's the -- one of the bigger drivers of the COVID costs?

Well, look, net COVID costs reflect expanded employee benefits, including, for us anyways, enhanced backup childcare and adult care as well as supplemental pay for employees in our financial centers and call centers. It reflects the technology costs to enable remote working as well as protective shields, enhanced site cleaning plus all the PPP-related costs, guards, lunches. It's all that sort of stuff we're doing to make sure that we can deliver for our customers. And the only way we can be sure we can deliver to our customers is making sure our employees have everything they need to do their work. So it's -- that's what's driving all those costs. Additionally, if you look at the third quarter, they were especially elevated, and again, I mentioned it because we had a lot of processing costs for really an unprecedented level of unemployment insurance. We help the states get that money to individuals. Now -- but these elevated costs are partially offset by lower travel and related costs as well as some less marketing spend during this health care crisis.

Very good. Over the years, your company, along with your peers, have spent billions of dollars on technology investing. Maybe you could share with us what's the outlook for technology investing? And tying into that, you've been one of the more successful banks in using the digital channel, particularly in the Consumer side. Maybe share with us any in-trends that are obviously been improving in digital due to the COVID situation, maybe wrapping it up in technology spending and what the outlook is for that.

Sure. Well, we've consistently been investing a little more than $3 billion annually on new technology initiatives over the past decade and that's part of our $10 billion annual tech spend. We don't see much change in the pace of that investment, we can talk a little bit more about that. You can see the results and progress on this investment, probably most clearly in our leading-edge digital capabilities that you referenced in your question. There's lots of examples of that. But Erica, for example, is up to 16 million users. Zelle has 12 million users. And this is all part of our high-tech, high-touch strategy we enacted years ago. It's not just in Consumer, by the way. Merrill Lynch, the private bank, Global Banking all have outstanding digital offerings to complement our high-touch strategy. And by the way, you can also see the focus on innovation in another way. If you look at the number of patents that we have filed and been granted, that was a record number in the first half of 2020. It's been -- it's up 20% year-over-year. In terms of thinking about that, the sustainability of that, we talk to a lot of shareholders. We're not hearing from shareholders that they want us to be cutting back on that investment. We run the company for long-term sustainability, which means we're constantly focused on operational excellence every day as opposed to one-off cost-cutting plans, and that has enabled us to create savings and to create the capacity to invest in the business and keep that technology investment at that $3 billion or higher level for many, many years now. So that -- as we sit here today, that's how I would ask you to think about it.

Got it. And we're coming to the last 5 minutes, and I would like to get to a question or 2 from the audience. And one question it has to do with this, Paul. Obviously, Bank of America has been active in returning their excess capital. We know the Federal Reserve now has put a temporary suspension on share repurchases for all the large banks. Can you share with us your outlook for capital action plans assuming if the Fed does lift that gate on share repurchases next year? What some of the actions Bank of America could take? And could you remind us the targeted CET1 ratio that you guys like to manage to? And the last reminder, is that your binding constraint when it comes to capital?

Sure. Okay. So as we entered the third quarter, we had a CET1 ratio of 11.9%, which is 240 basis points above our regulatory minimum or a $35 billion cushion of excess capital to that regulatory minimum of 9.5%. Once the FRB lifts the restriction and the SCB framework becomes effective, we are, I would say, very well positioned to start returning excess capital to our shareholders and at the same time serve customers and communities. As I said, we have a $35 billion cushion. We don't need $35 billion in cushion to do -- to deliver our purpose in a way that's consistent with our values and grow this company. So our CET1 ratio -- and by the way, that $35 billion cushion, you have to remember, is in the middle of one of the worst economic environments that we've seen in years and years and years. And we built capital since the end of the year during this environment. So our CET1 ratio, you asked what's the binding constraint -- our CET1 ratio is a binding constraint. And our SCB is 2.5%, again, another reflection of how we run the company. Our stress depletion was actually around 1.5%, and we have 50 basis points of dividend. So we're 50 basis points below the floor in terms of our actual SCB, again, a reflection of how we run the company and the risk profile of the company. And again, relative to peers, we had -- that's one of the lowest stress depletion levels in CCAR. And we probably have more cushion than most banks, certainly our major peers. So did I answer all your questions? I can't remember now.

No, no. That's good. And I won't ask you when you think the Fed will lift the gate since it's a guess for any of us, obviously. As the pandemic goes away, that's going to be one of the probably binding factors from them. Another more macro question coming in over the transom here. You guys obviously are quite strong in Consumer. Can you give us your views of what you're seeing in the housing market and in the mortgage market and how you're approaching that business today in view of the strength in that business?

Sure. Look, the refinancing market has been very strong. The housing market has been solid, I've got some data on it actually. We have been disciplined on pricing for a couple of quarters now. We've relaxed that a little bit because we have to stay competitive, but we have tried to lead the market on pricing. And so we'll probably pick up -- you should see the effect of that coming through not in the fourth quarter because there's a lag. But certainly, as we get into next year, you'll see the effect of that. But the housing market is -- demand is there, right? The demand is there for refinancings. The demand is there for people who want to buy homes who perhaps maybe want to get out of more concentrated areas and have a place that feels safer to them. We don't expect, by the way, the pace of refinancings to grow from here. We do think there's some refinancing fatigue. And now that interest rates are sort of settled at this lower level, we're not expecting the refinancing rates to increase. And that's important because, obviously, from an NII perspective, NII is affected by the write-off of premium on our mortgage securities, which are tied to the pace of refinancing. The demand for housing, I think, is probably higher than the supply. And so again, that's a positive if you think about kind of where we're heading here in terms of grinding out of this pandemic because people are going to have to mobilize to meet that demand. So that would be my perspective.

Yes. Well, with that, Paul, thank you so much. We're running out of time here. And really, on behalf of the Board of Directors of the BancAnalysts Association of Boston, we really thank you and Bank of America for joining us this year. And hopefully, next year, we'll get to see Lee and Brian in an in-person event, like you guys have done in the past. So thank you again.

We're looking forward to it. Thank you for inviting us. Talk to you later.

Okay. Thank you, again, Paul. Have a good day. Bye.