November 25, 2020

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Forensic Review of Bank of America's 2Q2020 Earnings - It's Ugly!

  1. Introduction

Bank of America ("BOA or the Bank"), the 2nd largest Bank in the US by asset size, has exceeded its earnings expectation and reported a net income of USD3.53 billion in Q2 2020. However, the net revenues reported for Q2 2020 is USD22.5 billion, barely edged out analysts' estimates of USD22 billion. Net income of the Consumer Banking segment is reported at USD71 million in the 2Q 2020, which has drastically declined from USD1.8 billion recorded in Q1 2020. Federal Governments' emergency rate reductions have curbed the Bank's net interest income. The Bank has reported a net interest income of USD10.85 billion in Q2 2020, which has declined from its previous quarter as well as last year's period value. However, the non-interest income has increased and reported an income of USD11.48 billion compared to USD10.64 billion in Q1 2020 and USD10.90 billion in Q2 2020. Net interest yield rate stood at 1.87% in Q2 2020 compared to 2.33% in Q1 2020. The Bank has maintained a provision of USD5.12 billion for credit losses in Q2 2020.

BOA is feeling the effects of COVID-19 more acutely as its business is more consumer-focused. The plunge in “real” economic activity” and “actual” economic value of BOA has placed downward pressure on the Bank's consumer banking segment, which is tied to the health and financials of millions of American consumers and borrowers. Hence, BOA is considered as the most sensitive of the large banks by analysts when it comes to fluctuation in interest rates.

Let us get a detailed view of its earnings.

Net Income

BOA has reported a net income of USD3.5 billion in Q2 2020 compared to a net income of USD7.3 billion in Q2 2019. Net income of the Bank's major segment, i.e., Consumer Banking, has declined drastically in Q2 2020 and reported a net income of USD71 million compared to USD3.3 billion in Q2 2019. This is primarily due to Federal Governments emergency cut in interest rates as well as rising unemployment. The Global Wealth & Investment Management segment reported a net income of USD624 million in Q2 2020, which has also declined from the USD1.08 billion in Q2 2019. The Global Banking and Global Market segment's net income in Q2 2020 have declined from the same quarter previous year but has increased from the previous quarter's income. Net income of Global Banking and Global Market segments reported at USD726 million and USD1.90 billion in Q2 2020 compared to USD136 million and USD1.71 billion in Q1 2019. Other net income has increased to USD216 million in Q2 2020, from a net loss of USD493 million in Q1 2020 and USD9 million in Q2 2019.

Figure 1: Bof A Segment-wise Net Income Trend (in USD millions)

 

Source: Bank of America Earnings Release, 2Q 2020

Net Interest Income & Non-Interest Income

BOA reported a net interest income of USD10.85 billion in Q2 2020 compared to USD12.19 billion in Q2 2019. The net interest income has declined with interest rate cuts by the Federal Reserve. However, non-interest income has increased to USD11.48 billion in Q2 2020 from USD10.90 billion in Q2 2019, primarily because of an increase in underwriting income and financial advisory services.

Figure 2: B of A Net Interest Income & Non-Interest Income (in USD millions)

Source: Bank of America Earnings Release, 2Q 2020

Profit Provisioned for Credit Losses

BOA reserved 72% of its pre-provision profit as a provision for credit losses. The Bank has provisioned 97% of total Consumer Banking segment profit for credit losses followed by Global Banking segment with a provision of 65.3% of the pre-provision profit. The Bank has reserved 14.1%, 3.9% and 3.7% pre-provision profit of Global Wealth & Investment Management, Global markets and other segments, respectively.

Figure 3: B of A Profit Provisioned for Credit Losses (in %)

 

Source: Bank of America Earnings Release, 2Q 2020

Return-on-Equity (ROE)

BOA's ROE has declined to 5.3% in the Q2 2020 from 11.0% in Q2 2019. The drastic decline in the Consumer Banking profit has impacted the ROE of the Bank.

Figure 4: B of A Return-on-Equity(in %)

 

Source: Bank of America Earnings Release, 2Q 2020

Net Interest Margin

The net interest margins is an indicator of the Bank's ability to lend money at an interest rate higher than the interest rate it pays on its deposits. The emergency cut of interest rate by the Fed has put downward pressure on its net interest margins. Notably, net interest rate margin of BOA has declined from 2.4% in Q2 2019 to 1.9% in Q2 2020.

 

Figure 5: BofA Net Interest Margin (in %)

Source: Bank of America Earnings Release, 2Q 2020

Balance Sheet Interest Rate Analysis

Earning Assets

The interest rate of BOA declined in Q2 2020. The interest rate of trading assets declined primarily because of a significant decline in the interest rates of Federal deposits, time deposits and short-term investments and Federal securities borrowed under the agreement of reselling in Q2 2020. The interest rate of commercial assets has declined primarily because of a decline in interest rates of the commercial real estate sector. The interest rate of the Consumer Banking segment declined with the decline in the interest rates of home equity sector.

Figure 6: Earning Assets Interest Rate Analysis (in %)

Source: Bank of America Earnings Release, 2Q 2020

 

Interest-bearing liabilities

The rates of interest-bearing deposits of BOA have also declined in Q2 2020. The interest rates of short-term borrowings and other interest-bearing liabilities have significantly declined and reached -10% in Q2 2020. The interest rates of total interest-bearing liabilities have declined to 1.61% in Q2 2020 from 0.41% in Q2 2019.

Bank of America is, in real time, refuting the erroneous assumption that inter-bank interest rates cannot go below zero because a lender would prefer to hold on to its money and receive no return rather than pay someone to borrow the money. This may be true for uncollateralized loans, but a lender may be willing to pay interest if the securities offered as collateral on a loan allow it to meet a delivery obligation (D’Avolio 2002; Jones and Lamont 2002), i.e. treasuries or certain equities. These are the treasury FTDs (fail-to-delivers) for the month of June. Which bank do you think is proximal to these FTDs on the 11th of June?

Figure 7: Interest Rate Analysis of Interest Bearing Deposits (in %)

Source: Bank of America Earnings Release, 2Q 2020

Funding and Liquidity

BOA's liquidity position in Q2 2020 has improved from Q2 2019. In Q2 2020, the Bank's liquidity position stood at USD2,776 billion.

Figure 8: Funding and Liquidity (in USD billion)

Source: Bank of America Earnings Release, 2Q 2020

 

Global Liquidity Sources include cash and high-quality, liquid, unencumbered securities, inclusive of US government securities, US agency securities, US agency MBS, and a select group of non-US government and supranational securities, and other investment-grade securities, and are readily available to meet funding requirements as they arise. Federal Reserve Discount Window or Federal Home Loan Bank borrowing capacity is excluded from the source.

Commercial Credit Exposure by Company

Credit exposure is the measurement of the maximum potential loss to a lender if the borrower defaults on payment. It is a calculated risk to doing business as a bank. The global pandemic has significantly affected industries, resulting in lost revenues and disrupted supply chains on account of lockdown measures and there residual effects. Industries such as real-estate, retailing, consumer services, food beverage and tobacco, transportation, consumer durables and apparels, vehicle dealers and automobile and components are highly susceptible due to lockdowns and restriction measures. BOA has a significant amount of credit exposures to these sectors.

 

 

Particulars

Commercial Utilized

Total Commercial Committed

June 30th 
2020

March 31st 
2020

June 30th 
2019

June 30th 
2020

March 31st 
2020

June 30th 
2019

In USD billions

           

Asset managers and funds

64.2

75.6

70.2

100.8

111.5

108.0

Real estate

74.2

76.0

66.9

96.1

95.8

89.7

Capital goods

47.7

48.3

39.6

85.7

85.5

75.1

Finance companies

40.7

46.1

39.1

63.8

66.6

62.9

Healthcare equipment and services

39.7

40.7

35.4

63.8

58.7

57.1

Government and public education

43.8

45.2

42.4

56.0

56.3

54.4

Materials

28.8

30.7

27.9

52.4

53.3

52.3

Retailing

29.6

33.5

26.5

49.8

49.5

47.9

Consumer services

34.2

34.8

25.8

48.3

46.3

47.2

Food, beverage and tobacco

24.6

28.0

25.4

46.2

47.8

45.6

Commercial services and supplies

24.7

25.6

22.2

38.1

36.8

37.8

Energy

17.0

18.3

15.0

37.4

38.0

37.4

Transportation

26.3

28.2

24.8

35.5

36.5

34.5

Utilities

13.3

14.5

12.1

30.0

31.7

31.3

Individuals and trusts

20.5

20.1

18.9

28.4

28.7

25.8

Global commercial banks

25.1

31.3

28.4

27.5

33.5

31.4

Media

14.5

13.6

12.1

26.4

24.5

24.8

Technology hardware and equipment

10.3

12.8

9.4

22.5

23.8

21.7

Consumer durables and apparel

10.9

12.6

10.3

21.1

20.5

20.0

Software and services

11.7

11.3

10.4

21.0

19.8

19.7

Vehicle dealers

15.4

18.3

17.7

19.8

21.2

20.8

Automobiles and components

12.4

11.8

7.8

18.6

17.3

15.0

Pharmaceuticals and biotechnology

6.8

6.3

6.1

17.6

19.6

16.5

Insurance

6.8

7.9

6.1

14.2

15.3

13.2

Telecommunication services

7.9

10.1

8.9

13.6

15.9

15.3

Food and staples retailing

6.4

6.8

5.9

10.6

10.7

9.8

Financial markets infrastructure (clearinghouses)

4.9

7.1

9.7

7.3

9.5

11.4

Religious and social organizations

5.4

4.4

4.0

7.2

6.1

5.9

Total commercial credit exposure by industry

667.7

719.9

628.8

1,059.5

1,080.7

1,032.5

 

BOA's total committed commercial credit exposure as on June 30, 2020 stood at USD1,060 billion, and total utilized commercial credit exposure stood at USD668 billion. BOA has the highest credit exposure in ‘asset managers and funds’ segment (expect this to get drawn upon when leveraged long or short positions go awry), followed by the ‘real estate’ sector (‘nuff said) and ‘capital goods’ market (straight consumer exposure during and economic depression).

As of June 30 2020, the total committed credit exposure of ‘asset management’ sector stood at USD101 billion out of which USD64.2 billion credit has been utilized. BOA's total committed credit exposure in the real estate sector (the hardest hit sector by the pandemic) stood at USD96.1 billion in Q2 2020 out of which USD74.2 billion is utilized.

Non-Performing Loans (NPLs)

BOA reported total non-performing loans of USD4.4 billion in Q2 2020 compared to NPLs of USD4.2 billion in Q2 2019. The Bank’s NPLs has increased with an increase in the NPLs of commercial loans.

Total NPLs in the consumer loan segment has declined in Q2 2020 and reached USD2.2 billion from USD3.0 billion in Q2 2019. The NPLs declined primarily because of a decline in NPLs of home equity loans as the Bank has charged-off a significant portion of loans during the one-year period.

Figure 9: Non-Performing Loans – Consumer Loans  (in USD billion)

Source: Bank of America Earnings Release, 2Q 2020

 

However, Commercial sector NPLs increased in Q2 2020. The total commercial NPLs in Q2 2020 stood at USD2.2 billion compared USD1.2 billion in Q2 2019 (an 83.3% YoY increase). The Commercial sector NPLs increased with the increase in the US commercial, Non-US commercial and commercial real estate sector. The NPL related to commercial, Non-US commercial and commercial real estate sector stood at USD1.2 billion, USD387 million and USD474 million in Q2 2020 compared to USD820 million, USD122 million and USD112 million in Q2 2019 respectively.

 

 

Figure 10: Non-Performing Loans – Commercial Loans  (in USD billion)

Source: Bank of America Earnings Release, 2Q 2020

 

Loan Delinquency rate and Charge-off

BOA, in its 2Q 2020 results reported 30+ days loan delinquency rate of 1.7% in the Consumer Banking segment (credit cards). The delinquency rate of credit card loans have not changed much throughout the last five quarters and even declined in Q2 2020.

Figure 11: 30+ Days or More Loan Delinquency Rate – As Reported (in %)

 

Source: Bank of America Earnings Release, 2Q 2020

A similar scenario is seen in the 90+ days or more credit card delinquency rates also. The loan delinquency rate of 90+ days or more has also declined in Q2 2020 from its previous quarter's level. In Q2 2020, the Bank has reported 90+ days or more delinquency rate of 0.93%.

 

 

Figure 12: 90+ Days or More Delinquency Rate – As Reported (in USD millions)

 

Source: Bank of America Earnings Release, 2Q 2020

 

The above data is as reported in BofA’s earnings release. But if we delve in, we can see a completely different picture of the delinquency rates of credit cards. The actual, economic delinquency rates have a considerable difference than the reported one.

On March 16th 2020, BOA enacted the Client Assistance Program where it offers assistance to 66 million consumers and small business clients in response to the unprecedented challenges of COVID-19, allowing the clients to defer payments. BOA has processed approximately 1.8 million total deferrals, and as of July 9th, the Bank still has 1.7 million deferrals. The deferrals represent USD29.8 billion of consumer balances.

If we add back this deferral amount to the reported delinquency amount of credit cards a completely different, and in our professional opinion – a considerably more revealing, honest and informational, scenario in delinquency rates comes out. The actual 30+ days and delinquency rate is 37.1% compared to the reported 30+ days delinquency rate of 1.7%. That is a difference of nearly 2,200%! Misleading, to put it lightly.

Figure 13: 30+ Day Delinquency Rate w/COVID Emergency Deferrals, As Adjusted by Veritaseum Research (in %)

Source: Veritaseum Research

 

BOA's actual 30+ day consumer loans delinquency amount stood at USD31.2 billion in Q2 2020 compared to reported 30+ day delinquency amount of USD1.4 billion. More alarming is that BOA's allowance for loan losses in Q2 2020 is USD9.2 billion, which is only 30% of the actual delinquent amount.  

Figure 10: 30+ Day Delinquency Rate w/COVID Emergency Deferrals, As Adjusted by Veritaseum Research (in USD billions)

Source: Veritaseum Research

  1. Conclusion

The US economy has been experiencing a significant and unprecedent material slowdown over the past few quarters due to the global pandemic, COVID-19 in combination with the deflation of a drawn out bubble that’s been blowing for over a decade. The pandemic has affected businesses with lost revenue and disrupted supply chains on account of lockdown measures. Industries such as Retailing, Consumer Services, Food Beverage and Tobacco, Transportations etc. are the worst affected and are highly susceptible. BOA has a significant amount of credit exposures in these sectors, signifying a huge impact on its earnings.

However, BOA in its Q2 2020 earnings has surpassed the earnings expectations and reported a net income of USD3.5 billion. The Bank's Consumer banking segment was hugely affected by the emergency interest rate cuts by the Federal Government and reported a net income of USD71 million. The Bank has reported USD11.5 billion non-interest income which has increased in this quarter primarily because of an increase in underwriting income and financial advisory services. However, the ROE and the net interest margin of BOA has declined in Q2 2020.

BOA has a provisioned 72% of its pre-provision GAAP earnings for credit losses in Q2 2020. The Bank's liquidity position has improved from the previous quarter and stood at USD2,776 billion. The Bank's NPLs were reported at USD4.4 billion.

The Bank's delinquency rates have declined and have reported a delinquency rate of 1.7% in Q2 2020. This is mainly because the Bank has enacted the Client Assistance Program under which it has allowed its clients to defer payments and excluded the total deferral amount of USD29.8 billion. Although this may adhere to GAAP (generally accepted accounting principles) guidelines, it is tantamount to prestidigitation and misdirection. This provides a misleading picture of the Bank’s financials. When we add back the amount set under the program, the delinquency rate increases to 37.06%. This indicates a big wave of defaults expected to come in the next few quarters, of which BofA is woefully under-provisioned for. Although BofA is in particularly bad shape in the is regard, it is not alone. JP Morgan, the largest bank in the US by assets, and arguably one of the better managed banks, is in the exact same predicament, using the exact same parlour tricks to hide the credit quality damage to tis balance sheet. Reference “Analysis of JP Morgan's Terrible, Horrible, No Good 2nd Quarter of 2020 - Why Am I the Only One?

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Last modified on Tuesday, 27 October 2020 05:46
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