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

Okay, thank you, everybody, for joining us for our 13th Annual Morgan Stanley Financials Conference. I am thrilled to have with us today Alastair Borthwick, CFO of Bank of America.

Alastair, it's been a delight to be working with you just for a little bit of time here. You've been in the job, I think, just over 6 months, is that right? Now in that 6 months, quite a lot has changed. We've had COVID resurgence, reopening, economic growth hopes, inflation and now recession fears. So it feels like you've gone through a whole cycle just in 6 months. Can you just give us an update on what you've been seeing, what you've been seeing in consumer spending in particular and account balances, how that's been going?

Yes. So we obviously -- let me say first, thank you for having me. very kind. I'm glad to be here, nice to see everyone live and in person. We get the question on the consumer, obviously, daily now. And our institute is trying to publish more and more statistics about what we're seeing. I think most importantly, in terms of spend, June to date is up 9% year-over-year. I remember that's coming off a record year, coming off another record year. So at this point, the consumer is still spending pretty robustly. And then in terms of balances, Brian talked about this a couple of weeks ago. We're still seeing the balances in each of the cohorts grow this quarter. Pre pandemic, if you're looking in that sort of $1,000 to $2,500 cohort, people have got about 7x, 7.5x more cash in their account today than they had pre-pandemic For the group that's in the $2,500 to $5,000 cohort, they've got 5x more than they had pre pandemic. So we're still seeing very healthy balance sheets and healthy spending.

And that's on the deposit side, right? And on the credit card side?

Credit card balances, still just a little lower on average. So that, again, it's sort of a testament to just the health of the consumer, I'd say, in terms of they're not overextended in terms of leverage. And we're seeing after Q1 when we typically see a little bit of a seasonal slowdown, credit card growth this quarter has been pretty good.

Okay. Maybe we could just dig in a little bit on that question to where at the lowest end where you're saying they're still up. Is there any changes Q-on-Q at all or still steady as she goes?

No, not yet. Still seeing growth there.

Can you give us a little sense as to what's going on in the lending side outside of card? So -- and spend? Maybe the card loans; revolvers within card, auto, which has been very strong; mortgages, which look like growth is accelerating. People are asking if it's just a function of prepay speeds slowing down, or is there anything else going on there?

So across the board right now, we're still reasonably good loans growth. We've talked about the fact that we feel like this will be an above-average year for loans growth. Normally, we think about GDP plus because we feel like we should be able to take a little bit of market share each year. This year, obviously, GDP is a little higher. And on top of that, we feel like there are some things as the economy normalizes and as revolver grows and payments slow, both on the consumer side and the commercial side. We should see high single digits growth in loans. We're still on track for that. We feel pretty good about this quarter. So it's a good loans growth environment.

And is that in mortgage growth increasing, accelerating due to simply prepay slowing down? Or are you doing something in HELOC or home equity loans that we should be thinking about as well?

Well, we haven't changed anything in terms of strategy. I wouldn't say mortgages necessarily accelerating. I'd say it's the same kind of growth trajectory that we've been on. Our prepays have obviously slowed but they're just keeping pace and continuing to grow the book, and it's just about adding new clients over time.

And what about commercial?

Commercial has been very strong, continues to be that way. We've got a couple of things going there, the first one, obviously, is the economy continues to heal. So people are borrowing more as they see pretty good growth themselves. And then the second thing we've talked about this before, is we got to a point in the pandemic where revolver utilization was far below the average. And every quarter, it just keeps creeping back up towards the average, that can still run some more. It's been a pretty good tailwind for us in terms of loans growth, and that trend continues. So we'll talk about that more on earnings.

Okay. So just finishing up on trends, quarter-to-date, what about credit?

So that's a good question to get at the time right now. And credit remains really strong. Last quarter, we had 16 basis points of net charge-offs, up from 15, which was our historic low. And the consumer is just in great shape. So where we first look is, is there any in 90 days past due or 30 to 60 or even 5 days? Has there really been no material change there at all in the consumer side? And on the commercial side this quarter, our upgrades are probably 2:1 relative to downgrades. So again, you've still got this healing coming through the entire economy. And in things like travel and restaurants and hotels, you're still seeing credit quality improve pretty significantly.

So I just want to have a bit of a moment here on that. You're saying that your commercial loans are 2:1 upgrade.

Currently this quarter, yes.

Interesting. Okay. I say interesting because there's been such a concern around recession imminently approaching. And you're not seeing that in your book?

No. So there's this dichotomy. There's this question of what will happen in the future, and there's what are we seeing right now. And what we're seeing right now, credit is in great shape. And look, I'd expect it to bump around because we're at such low levels. And one would think over time, it would trend back towards history, but we don't see that right now.

Other question for the quarter is around the NII outlook. Now this is one place that you have given some specific numerical guidance in your past comments during earnings. I think you were saying that NII, you were looking for up 650 Q-on-Q. Is that right?

Yes, we said 650, maybe more. And we haven't changed our thought process there. The reason we don't tend to give a lot of guidance going out a year because we don't control what the Fed does. And we don't -- we can't tell how many upgrades, how many times they'll hike rates. We can't tell when. And we don't know how big they will all be. So everyone in this room is as good as we are predicting that. We tend to use the forward curve and what's embedded there. I'd say this quarter, we're still on track for 650, maybe a little bit more. And then what we said also during the last earnings was we felt like Q3 -- if Q1, let's say, we were up 200, but if you day count adjusted, we'd get up to 400. So we accelerated in Q2 to 650 plus. Q3 should accelerate again, so we expect a step-up there. But we'll talk about that at earnings when we're a little closer and when we feel like we've given that some proper thought.

Okay. So what you're saying is Q-on-Q, net interest income, up 650 plus in 2Q. And in 3Q at this stage, you're expecting an even higher step-up Q-on-Q.

Yes. You can sort of see that like when we talk about up 100 being worth $5.4 billion. Like that's how you get there. You need a couple of successive increases.

Now Brian mentioned trading was running at about up 10% to 15% year-on-year, last week, I believe. Is that still the case?

Yes, no changes in the last week. The trading team has done a great job along the volatility. That continues to be a business we're investing in. Very constructive there, we've got great clients. So we think 10% to 15% is probably about the right speed right now.

And banking fees still looking for $1 billion to $1.25 billion for the quarter.

Yes. The investment banking environment for fees has been very challenging this quarter, particularly in equity capital markets. That's been true for everyone. I think we've probably captured a little bit of market share, but it's off a really low base, obviously. So somewhere in that $1 billion to a billion and a quarter. And then the other thing that we just have to be thoughtful about is we're likely to have some leverage finance write-downs. We think that could be $100, $150 million or so just with positions that we have with the risk that we take for our clients. That won't flow through the investment banking and sales and trading numbers, that will flow through all other, but we're keeping an eye on that...

All other?

Through other income, pardon me.

So it's a contra revenue.

Yes.

Okay. All other income contra revenue. Just making sure.

Other income. Yes.

Got it. Okay. So I'm going to flip now to talking a little bit about the balance sheet. And I have to say, I was very impressed in the last quarter when you announced your results that you had such a small AOCI hit, that was great. You've been really nimble over the past couple of years, adding with the swap book and everything. So I just wanted to understand the thought process behind making that change. And you're a large institution, but you're extraordinarily nimble it seems.

Well, what you're referring to, I think, is we've got $200 billion of treasuries in our AFS portfolio that we swapped to floating. So it really insulates us. Obviously, when rates go up, we get the benefit on the swap side. That predates me. That was a decision made by Brian and Paul. And it's really just a philosophy that once we fund all the loans growth we want to do, we're going to have some excess. And some of that, we can put in securities. And most of that will put in our hold-to-maturity book. But there'll still be some left over. A lot of that cash we put at the central banks, that gives us ultimate flexibility. And we have $200 billion of treasuries that are swapped which, again, we're not necessarily looking for a duration risk there. We're not necessarily looking for credit risk there. We just want to have a lot of flexibility for future loans growth or possibly one day, we might take that off and have some luck in higher interest rates. Or if ever we were to see deposit runoff, then obviously, we've got $200 billion that sits there in addition to the cash. So it affords us a lot of flexibility, and that's why it's there. But it's not really there is an earning asset.

Okay. Just wanted to also ask a little bit about the HTM book that you've got, $500 billion in HTM, right? It's over half the securities in your portfolio. And I believe that your consumer banking and wealth deposits are almost double your HTM book. Is that right? Could you just talk through your duration assumptions around both of those pieces?

Yes. So the mortgage portfolio, obviously, is reasonably long duration. Obviously, it pays down every year. And then we get prepayments and the prepayments, depending on a lot of different things, including interest rates, but just people moving homes, et cetera. So with interest rates having backed up, the duration of that portfolio is extended. At some point, it stops extending because you no longer have a prepayment for rate opportunity in the book. So what will end up happening is, in any given quarter, we'll end up having $15 billion to $20 billion come out of that portfolio as it amortizes and as it prepays. That allows us to take that and either put it in loans, or reinvest it in securities at higher rates. So that's going on with the mortgage book. On the deposit side, the duration of our deposits both on the consumer side and the commercial side tends to be pretty long dated, too. For 9 years, I ran the commercial part of the bank. And there, our average client relationship might be 20 years. So we're going to have their deposits for 20 years. So we kind of need long-dated assets against our long-dated liabilities. And on the consumer side, the same thing. Most of what we're trying to gather is core operating accounts from college kids who might be with us all the way through until their retirement years. So we've got some pretty long-dated deposits as well, and we feel like that's a good match.

Okay. Yes, your loan-to-deposit ratio is also very low at this stage, right, running in the 40s. Is that right?

Maybe 50.

50, okay. And the question there is, before the pandemic, it was in the 70s. So I'm just trying to understand, like how should I model this going forward? How high are you willing to let your loan-to-deposit ratio go? And I asked because last quarter, you did have end of period loans up, I think, around $14 billion, which was double the pace of the end-of-period deposits. So some people might look at that and say, oh my gosh, deposits aren't growing as fast, but on the other hand, you have a huge amount of room in the balance sheet to fund loan growth with all the liquidity we just discussed.

Yes. So I wouldn't think about it quarter-to-quarter because like, for example, Q2 is a period where we have typical seasonal deposit outflows with just taxes and things like that. And like the commercial business really only builds deposits in Q3 and Q4. So longer, if you take a look at the big picture, when we show the loans graph daily, in the pandemic, there's a brief spike followed by an enormous dip in lending as clients decided to get a little more conservative and draw back on leverage. During that period, we gathered an awful lot of deposits with the fiscal stimulus. And with the excess, we put that in securities. So the deposit side was going up and the loans were coming down. So that's why we went from 70-ish to under 50. Today, we're back to more normal. And in more normal, what will happen is we'll generate deposit growth, and our first choice will always be loans. And then if we have anything left over, we'll put it in securities. At the same time, the securities portfolio kicks off $15 billion or $20 billion every quarter. That can go into loans if it's there. So we may not grow the securities portfolio, it may shrink over time. We don't make a judgment on that. We're just -- priority one will be just fund the customer growth. And then if there's liquidity left over, we'll decide, do we add some to the held to maturity mortgages or do we add some more swap treasuries, just depending on how much flexibility we want.

Right. And so this loan-to-deposit ratio that a lot of folks are thinking about, that's an output for you, right?

And it will take us a long time. Like we can fund an awful lot of growth. A lot.

We heard from Holly a couple of weeks ago that consumer deposit betas should track roughly in line with last cycle. And she pointed to the strong consumer franchise in particular. Could you just give us a sense of why that's the case that the deposit betas should track roughly in line? Is that still the expectation?

Yes, it's still the expectation. I mean I'll provide a caveat at the end, but we add a lot of value to customers. And the switching cost from where they are with an integrated app that allows them to do an awful lot of their financial life quickly, easily, securely offers a lot of value, and so probably more even than 4 and 5 years ago when we went through the last cycle. So we anticipate that deposit basis should be the same. We're hoping for slightly better. And then I guess the question will become this time, it's a little different in that we've got quantitative tightening. So that's 1 thing. And then the second thing is we don't yet know how high rates will go. We know how high it went in the last cycle. So there's an element of -- for that -- those first few rate moves you'd expect the deposit beta to be very similar to the same kind of rate structure. If as and when the rate structure goes much higher, one over time deposit betas may change. But that's how we're generally thinking about it.

And is there any difference between what you're expecting from the consumer franchise, the wealth franchise, the commercial franchise?

Yes, yes. I mean I think our consumer franchise should be the least sensitive. The very upper end of wealth is very sensitive. And commercial is dependent on whether it's the interest-bearing and the noninterest-bearing. Noninterest-bearing tends not to be particularly sensitive, more sensitive than consumer. Interest-bearing is a little more sensitive. So all these deposit bases, when we're talking about them, we were talking about the aggregate. They all behave differently. We price them differently we observe them differently, and we manage them actively. So we compete for the deposits where we need them, where we want them. But again, the core for us, the strategy is keep building core checking accounts, primary operating deposit accounts. On the commercial side, it's that operating account we're looking for. So we tend not to be looking for the sorts of balances that are looking for the highest rate on any given day.

I do want to drill down on that in one particular area, which is in treasury services because that's an area where for the corporate clients, you're toggling through this ECR rate to basically incent either them to pay you via hard dollar fees or by leaving deposits with you. And as rates are rising, if you did -- if you're just expressing that rate rise through the ECR, then maybe you're incenting less deposits in the -- as rates rise, your corporate clients don't have to hold as much deposits with you. Can you help us understand how you're managing that dynamic around treasury services as rates rise?

Yes. So First thing, we'll handle that the same way we have in every rate rise cycle. So this isn't new. We've been offering ECR for many years, and it's part of the deposit beta. There are essentially 2 different exercises going on at one time. The first one is we have a mentality that we're trying to grow gross fees every year. And that's what you would expect. We're trying to do more with our corporate customers and add more corporate customers over time. And when we are in the same price on higher volumes, we are on higher gross fees. So that's part one. Part two is we're trying to manage rate and we're thinking about what we need to offer to get the deposit growth we're looking for. Those 2, exactly the same. Where they intersect here is that we have some corporate customers who rather than pay us $200,000 of fees in the course of the year, they might prefer to just keep some balances with us, where we pay no rate, 0 rate. So that's just an expression on their part of choice. It's sometimes easier for them to not pay a fee than to earn interest and pay a fee. So the economics to our shareholder are the same, the economics to the customer are the same. And then we're just managing the pricing on that exactly the same way we would for any other deposit.

Right. But as rates rise, should we expect the corporate deposits to climb because...

In some cases, the corporates will rotate some of those noninterest-bearing into interest-bearing. But that's, again, that's something that happens in every cycle. And that's something we incorporate in our expectations around betas and around growth.

Got it. All right. Just ticking down the line on fees, things that are kind of popping up in the questions. The next one is on wealth with markets being down Q to date, not only in stock but also bonds as well. The question is, how should we expect your fees likely trend this quarter?

Well, I think you'll see the S&P 500 similar to what we do. So that's pretty transparent, you'll be able to back into that. The 2 parts of our wealth business, I think, are really interesting right now. First one, we continue -- we're going to keep doing what we can to control what we control. Mostly that's around adding net new households in both Merrill and the private bank. They've done a terrific job of that. They keep driving that. That organic growth machine is something we want to keep investing in to make sure they can do that. The second thing is our wealth business over time has grown a pretty substantial deposit base and a pretty substantial loans book. And we've continued to grow that pretty consistently now for the last several quarters. So they should get a pretty significant NII uplift to offset some of the fees. So I'd say, overall, we're obviously a receiver of where the S&P is, nothing we can do there, but there's a lot of things we can do to just make sure that we're growing that business.

Okay. And then lastly on fees, you changed the insufficient funds and overdraft fee recently, including bringing that per incident rate down to $10, which I think is a market low, which is good for you that you're leading the market on that one. I think you've guided to a $750 million impact this year. And I just wanted to understand how you're expecting that's going to materialize throughout the course of the year, and if there's any offsets that we should be thinking about.

So I think we took 80 or so in Q1, and we think we'll get the full run rate by the end of Q3.

Okay.

So that will give people an idea and that's sort of a step down. And offsetting that, I'd say there are 2 things that are hard for us to give a precise number on. But the first one is that because we don't charge those insufficient funds and overdraft fees. We get a lot less call volume in the call centers saying, I got charged this and can you help me out here because I had a particular situation. And that takes up a lot of time and a lot of expense. So we'd expect the expense side to come down a little bit. And we'll be able to observe that over time. So we'll begin to get a point of view on that. And then the second thing is client satisfaction goes higher, and our attrition goes lower, and that's always good for us because that helps to drive net new customers. And it makes it more of a core relationship proposition, which is what we're trying to do. So first, people look at the sort of the headline. But underneath it, I think there are a couple of things that should offset.

So you bring up some great points on operating leverage that you're looking to drive as well, right? Maybe we could dig into that a little bit. One of the things in the 2015 to '18 period where you were delivering some nice operating leverage was coming from branch count shrinking. And now branch count is more stable, right? I mean there's a little bit of a decline if we round up to 1% or something, but it's really not as much as you had in the past. So I get the question a lot, what's going to drive your operating leverage if your branch count is more stable?

Well, we've talked about this before. We are an organic growth company, and we're investing a lot in our growth. We're hiring more bankers. We're renovating all of our financial centers. We are adding financial centers in some places. We increased our technology spend. We increased our marketing spend. So there's a lot of things that are going on to help drive growth. Second thing, we're very focused on generating operating leverage through the cycle. And we have to pay for that growth. And we have some interesting offsets. The first 1 is digital transformation. Brian talked about the fact that Zelle last quarter, for the first time, overtook checks. Those checks are expensive for us to process. So the more that they continue to come down, we're gaining on the expense side. Digital transformation is really good for us at operating leverage, both on the revenue side and on the expense side. So digital is a big part. The second thing you've heard us talk about before is that every quarter, we're running a series of operational excellence initiatives where we're looking at our processes. So within the CFO organization, we've got a series of processes and we've a number of people who own those processes and their job is to think about how do we make that better for the customer, cheaper for the shareholder. And there's savings from things that we invested 2 years ago that are coming online now. So we are constantly working in the process side for savings there. And then the third thing is there's still some COVID expenses that we're getting out. So we have some things that offset the investments we're making, and that's where if we get some NOI uplift, which we fully expect, we've got a good story on the revenue side, together with the organic growth plus the expense discipline should deliver the operating leverage we're looking for.

You brought up technology, obviously, a critical driver of the operating leverage. The consumer tech is fantastic, and we can see that in the mobile app rating, which is, I think, a 4.8 stars, one of the highest in the country. Can you help us understand what your tech side with wealth and with capital markets? Is there more to do on those 2 pieces?

Oh, yes. There's lots we can do there. We talk about being high tech and high touch for the consumer experience. And when you listen to Andy talking about modern Merrill, that's what he's talking about. It's this financial adviser relationship and the technology experience that people would expect. So some people want a self-directed account as well as having their own advisory relationship. And that's an important thing. And Merrill Edge helps to deliver that both for the consumer clients and for the wealth management clients. On the commercial side, things like Erica. Some of you would have used Erica before, it's our AI, you're on the phone, you ask, what's my balance? Erica will tell you. You can do some basic transactions on your phone using Erica. We took that, which is now tried and true with millions of customers every month and put it on the commercial side as a tool for our bankers to query for information about commercial clients. And Erica can spit out things a lot faster than a human being looking for them. So we take things that are used in consumer and deploy them in commercial to great success. Same thing with check, like today, will allow any commercial customer to not drive to a branch, but instead to deposit checks on phone. So simple things like that, taking paper out, automating the place, providing the client a better experience and ultimately save us money.

Okay. Great. I want to see if there's anybody in the room that has a question for Alastair before I keep going on. All right. Everyone is satisfied with the questioning so far. Steve [ Wharton ] has a question. Do we have a mic? It's coming.

I got here a little late, so forgive me if you've gone over this, but I just wanted to ask about the deposits again. You sort of alluded to the fact that you think the deposit beta on the initial rate rises will be in line or less than the last time. But I mean it looks pretty clear at this point, we're going to get a lot more rate rises than the last time, and then also maybe some material quantitative tightening. When you run your models, I'm just curious, if you entered into a period where deposits actually outflowed, sort of what would that then necessitate you do marginally to fund the balance sheet, deal with the asset side? And have you sort of game planned this? Because it seems like this could be coming. I just want to get a little bit more information on how you're thinking about it.

Yes. So a couple of things. First, we took a look over the course of the past several years at every time rates have gone up significantly, whether it's a 12-month spike or whether it is the peak rate environment. And in the 12 months prior in each of those occasions, we grew deposits right around 5%. So we can continue to grow deposits in a rising rates environment. Second, we're not passive in our deposit pricing, we're active. And that affords us the ability in each of the segments that Betsy talked about, whether it's consumer, whether it's wealth management, whether it is commercial interest-bearing and noninterest-bearing, we have the ability to price for the growth that we're looking for. So we're an active participant in pricing over time. Third, if we were to see deposit betas that we didn't like at some point and if we saw some runoff, that's 1 of the reasons we keep the balance sheet as flexible as we do. So we've got -- and we'll update you again at earnings for just how much we keep it in the central banks, but it's $100 billion, $150 billion or more; $200 billion of treasury swap to floating; another $50 billion of available-for-sale mortgages; $15 billion to $20 billion of inflows every quarter from our portfolio. So we have a lot of flexibility over time. And again, most of our deposits are not the sorts of deposits where we took something outsized from somebody, and they're just looking for the best rate. Most of our deposits are, somebody has $2,500 in their checking account, and that's an important number for them and their family, and they're using it as their core operating deposits.

Can I have 1 follow-up?

Sure, 2 minutes.

Do you -- I just have 1 follow-up. I mean I understand all that, especially on the consumer side, and that's what makes the franchise good. But at the same time, Brian has highlighted that across cohorts, the consumers have excess deposits. So do you factor that in? Post-COVID, you gave some numbers on the call about people that have this much in deposits typically are at this level and it's higher and et cetera. Do you sort of factor that into your planning that those numbers go back down to like pre-COVID levels?

Well, we run [ sliders ] on everything. As you know, we have a series of downside scenarios in just about everything we can think of. Right now, we can observe the customer behavior we see. And then we, like you, speculate on everything that could happen in the future. But it appears customers right now like that deposit balance and they like that behavior. And it would seem in an inflationary environment, their bills are going up as well. So they've got to be careful in terms of just managing their own household finances. So there may come a time when we're talking about that, and where we're concerned about that, but it's not on the horizon right now.

So 1 last question on capital. You've mentioned before that your common equity Tier 1 ratio of 10.4, you'd like to see that get to 10.75. Seems like that would be, with the earnings generation you have, not so hard of a stretch goal. But I guess the question I get is on buybacks and what that means for buybacks, if you could help us understand.

Yes, so no change to our philosophy here either. I think people here know, we've invested in our Global Markets business. We've had pretty good organic growth across the company, so that's going to push us into a new G-SIB category. So we'll go from 2.5% to 3% there. So that will take our regulatory minimum from 9.5 to 10. And we'd like to operate right around 75 basis points higher. So that's 10.75. And that will give us the task then of raising 35 basis points of capital in the course of the next 1.5 years. So last quarter, we generated 45 basis points. Our first priority is always going to be growth, which was about 20. Then the dividend, which was 11% last quarter. And everything left over, then we can choose to buy back shares and/or build capital. So if you think about what we have to do now in the context of 40 or 45 basis points, in a quarter, we've got to grow 35 to 50 basis points. That's 6 or 7, 8 basis points per quarter. And the rest we use for share buyback.

Okay. Great. Thank you. Thank you very much for joining us, Alastair.

Thanks for having me. Thank you, everyone.