Bank of America - Earnings Call - Q4 2011

Transcript

Speaker 2

Welcome to today's program. At this time, all participants are in a listen-only mode, and later you will have the opportunity to ask questions during the question and answer session. You may register to ask a question at any time by pressing the star and one on your touch-tone phone. Please note this call is being recorded, and I will be standing by should you need any assistance. It is now my pleasure to turn the conference over to Mr. Kevin Stitt. Please go ahead, sir.

Speaker 4

Good morning. Before Brian Moynihan and Bruce Thompson begin their comments, let me remind you that this presentation does contain some forward-looking statements regarding both our financial condition and financial results, and that these statements involve certain risks that may cause actual results in the future to be different from our current expectations. These factors include, among other things, changes in economic conditions, changes in interest rates, competitive pressures within the financial services industry, and legislative or regulatory requirements that may affect our businesses. For additional factors, please see our press release and SEC documents. With that, let me turn it over to Brian.

Speaker 1

Thanks, Kevin. Before Bruce begins, and good morning to everybody, before Bruce begins his portion of the presentation on the slide, I thought I'd make a few comments about 2011 and what we are focused on for 2012. For the last two years, we've been executing on a huge transformation here at Bank of America. After six large acquisitions in six years during the mid-2000s, then the economic crisis and its aftermath, we've set on a course to simplify the company, to streamline the company, to reduce the size of the company, to lower our risk, and build a fortress balance sheet. During that, we set goals to have 9% Basel I Tier 1 Common and 6% Tangible Common at year-end 2011. We set goals to reduce our non-core assets. We set goals to bring our credit risk down and to address the mortgage risk related to the Countrywide acquisition.

At the same time, we also set goals to continue to invest in the areas where our company can grow and has its competitive advantage. Areas like our Wealth Management area, areas like our Preferred and Small Business Banking areas where we've added preferred bankers and small business bankers, areas like our commercial corporate and investment banking areas, especially in large corporate investment banking outside the United States. Along the way, we had to address the issues that came up in mortgage, the slow recovering economy, which is moving forward, but not as fast as we'd all like, the European crisis, a muted interest rate outlook, and the revenue loss to the new regulations that have been passed. This then resulted in our focus on costs. We announced early last fall our New BAC program and the goals that we had for it.

As we think about 2011, we saw the following. First on capital and liquidity. This quarter, our Tier 1 Common equity ratio ended at 9.86%. Our Tangible Common equity ratio ended at 6.64%. In the case of each of these ratios, they are dramatic improvements from the beginning of the year. We made these improvements while absorbing significant mortgage-related costs during the year. We have ratios that are in line with our peers, and we expect further improvement due to the continued work on the balance sheet we'll make during 2012. In addition, our liquidity is and remains at record levels even after the downgrades we experienced in the fall. Moving from capital and liquidity to our core businesses. On slide two, you can see we continue to do what we're here for. We simply serve our clients and customers, and we do it very well.

Our core business activity continues to move forward. During 2011, we continued to grow our deposits and our investment assets for our personal customers. We originated 20% more in small business loans this year in 2011 than we did in 2010. This met our internal goals we had for that unit, but importantly also met our billion-dollar incremental goal we committed to the White House and the Small Business Administration a few months back. For our commercial clients and our corporate clients, we did what we're here to do. We provided more loans, more capital, and more market access here in the U.S. and around the world. For example, in the fourth quarter, you can see strong growth in our loan balances in our corporate area.

For our investor clients, we achieved the number one institutional investor overall research ranking, evidencing the quality of our ideas to match our capital to help them make their investments. In our mortgage business, we continue to reshape our operations to focus solely on origination of mortgages for our customers and to do it well. Importantly, we continue to help those who have difficulty making their payments in mortgages. We've now crossed over 1 million modified loans in our servicing portfolios. The third area we focused on after capital liquidity in the core businesses was costs. It's clear that we're going to grind forward with a recovery in this country. Our clients continue to push forward, and we're seeing the activity continue to move forward. A full recovery to what we would call normal may take some time.

With that in mind, we began to focus on bringing our costs down across the company. Our cost structure at Bank of America has two broad elements today. First, the costs we incur to deal with the mortgage issues, and second, the remaining costs to run the rest of the company for the benefit of our customers. Overall costs were down from 2010 to 2011, and we expect substantial cost savings in 2012. This quarter, you can see that starting to take hold. We made significant progress towards our overall FTE reduction goals. Our period end FTE is down about 7,000 people in the fourth quarter compared to the third quarter. This is over and above the 2,500 people we added in this quarter for our legacy asset servicing. There are two things about this. One, this shows that our New BAC implementation has begun in earnest.

Second, the good news is that we expect that LAS is at or near its peak staffing. The fourth area we've been concentrating on in 2011 was trading. Trading was strong in the first part of the year, but with the issues in Europe, the U.S. downgrades, the downgrade of our company, and changes in client risk appetite, results were weak in the second half, especially in the third quarter. However, during the fourth quarter, we partially recovered, as Bruce will talk about later. Yet we still reduced risk during the quarter to ensure we were well positioned to handle what might have come up. We still have work to do in trading, but the team got after this quarter as the quarter unfolded and we saw stronger results. From a credit risk perspective, you can see that our charge-offs and cover ratios continue to improve.

We ended the year with strong ratios. We also ended the year with $15.9 billion in rep and warranty liability reserves. We built significant litigation and other reserves in this area also. The four areas for 2011, it was all about raising capital and liquidity, driving the core businesses, managing the cost, and risk management. As we look at 2012, these themes are the same. First on capital and liquidity. Bruce will talk to you later about our targets as we look forward. The focus in this company is to continue to move through the Tier 1 10% level in Basel I Tier 1 Common and drive towards the Basel III implementation. Liquidity will remain high even as we continue to reduce our long-term debt footprint. The second area is cost. As I said earlier, we expect that operating costs of LAS are nearing peak.

As we finish the closure look back and we continue to reduce the delinquent units serviced by this group, we expect these costs to come down during 2012. Just for clarity, in this quarter, in the fourth quarter of 2011, LAS costs were $3.5 billion of our total costs. $1.5 billion of that was litigation in LAS. The remaining were operating costs. For the rest of the company, we had expenses about $16 billion in the fourth quarter, including $0.5 billion in goodwill write-downs. We expect to see in 2012 strong cost improvement consistent with our New BAC goals. Bruce will discuss these goals later. New BAC is doing what we expected, and the phase two evaluation is going well. As you know, headcount drives our costs. We saw a significant improvement in the fourth quarter, and we expect to see that as we move through 2012.

As we move to the core businesses in 2012, for 2012, we can now really focus on our retail strategy. In this quarter, you see the last part of the regulatory costs coming through. That's the Durbin interchange changes. We've now absorbed the Durbin, the Reg E, the CARD Act, and all the changes that occurred over the last couple of years. The focus here in consumer is to balance our customer and shareholder return needs and to continue to work on our cost structure, reducing branches as we've done this year. We're also going to continue to meet our customers' change of behaviors through our innovative offerings, especially to our 9 million plus mobile banking consumers. Trading continued to improve this quarter, as I said, and we have sized our business at times, and we look forward to continuing to improve in 2012.

LAS and mortgage will continue to take work during 2012, which won't be different in 2011. For the other businesses, we expect to generate strong core customer results. We also will continue to take advantage of the growth opportunities, garnering more customers and more depth in relationship with our customers. That should continue to provide the good returns on capital that you see in those businesses this quarter. As we think about risk for 2012, we expect to see continued improvement in credit risk as these legacy portfolios that we've identified for you continue to run off. Those legacy portfolios are a drag on earnings with much higher credit costs than the rest of the portfolios that we'll retain and drive as we go forward. We also expect in 2012 to continue to manage through the mortgage issues, relying in part on our significant reserves we built in 2011.

As we look forward to 2012, the focus remains the same as the last two years. Continue to drive capital and liquidity, continue to drive our core business growth where we have opportunities, continue to manage our costs well, and continue to manage the legacy residual risk down. As we think about 2012, we begin with a much stronger position, stronger capital and liquidity, stronger reserves, and that continues to give us optimism about the prospects for our franchise. With 2012, with much progress having been made on some of these legacy issues and the transformation over the last couple of years, we can take all the energy and talent we use to drive that and dedicate it to help drive our company's success. We look forward to doing that. With that, I'll turn it over to Bruce. Great. Thanks, Brian, and good morning, everyone.

I'm going to start my comments on page six of the slide presentation. As you all saw this morning, on an FTE basis, we reported net income of $2 billion or $0.15 a share during the fourth quarter of 2011. I'd like to bring your attention to several items in the quarter that had significant impacts on the income statement. First, in November, we sold the majority of the balance of our CCB shares, generating a gain of $2.9 billion. In addition to that, we exchanged trust-preferred securities into a combination of senior notes and common stock during the quarter, which generated a pre-tax gain of $1.2 billion. Lastly, we had gains on sales of debt securities of approximately $1.2 billion in the quarter.

Things that went against us through the income statement during the quarter, the tightening of our credit spreads generated a DVA loss of $474 million relating to our trading liabilities. As Brian referenced, we had a goodwill impairment charge of $581 million that we recognized during the quarter that related to a change in the estimated value of the European card business, and that's recorded in all other. During the quarter, we also had a credit mark on our structured liabilities under the fair value option that resulted in a negative mark of $814 million as a result of our credit spreads tightening, and that's reported in another income. As you think about that $814 million, keep in mind that whether positive or negative, it does not impact regulatory capital ratios, but it does impact GAAP capital.

Lastly, from a litigation perspective, we had expense in the quarter of $1.8 billion, of which $1.5 billion was mortgage related. If we flip to slide seven, there are a lot of numbers on this page, but I'd like to bring your attention to a couple of things. The first is, as you look from year-end 2010 to year-end 2011, you see a continued transformation of our balance sheet where all of the focus is moving to our core client activities. A couple of things to highlight. Total assets, and I'm speaking from third quarter to fourth quarter now, total assets for the quarter were down 4% or approximately $90 billion. From a risk-weighted asset perspective, risk-weighted assets were down 6% or $75 billion during the quarter. If we move down to Tier 1 Common Equity, Tier 1 Common Equity during the quarter increased $9 billion to $126.7 billion.

That increase in Tier 1 Common, along with the reduction in risk-weighted assets, led to our Tier 1 Common Equity ratio increasing from 8.65% to 9.86%. I'll go into that in a little bit more detail in a few minutes. Tangible Book Value per Common Share was down 2%, reflecting the fact that we issued 400 million shares in the exchanges that I referenced with respect to trust-preferred and preferred securities. You can see that 400 million shares in our outstanding common share change from the third quarter to the fourth quarter. If you move to the bottom, our allowance for loan loss reserves came down $1.3 billion during the quarter as we released reserves. Importantly, though, our allowance relative to annualized charge-offs improved from 1.7 times to 2.1 times at the end of the year. Lastly, our liability for representations and warranties remained relatively flat at approximately $16 billion.

If we move to slide eight, I thought it was important to give you a walkthrough of the drivers of the improvement in the Tier 1 Common Equity ratio. We start on the far left at 8.65%. As we've disclosed throughout the quarter, the preferred exchanges, the CCB sale of shares, and the Canadian consumer card sale in the aggregate generated 60 basis points of Tier 1 Common. Over and above that, 21 basis points coming from net income in change in deferred tax asset. Within the Global Markets business, about 18 basis points through reductions in market risk. Change in loan balances and other asset sales were about 10 basis points. You had a series of other things, both positives and negatives, that netted out to 12 basis points, which in the aggregate increased the number to 9.86% at the end of the year.

Moving from capital to liquidity, if you flip to slide nine, you can see that our global excess liquidity sources increased from $363 billion at the end of the third quarter to $378 billion at the end of the fourth quarter. As you think about those excess liquidity sources, recall that that does not include approximately $189 billion in additional liquidity that's available to our banking entities by pledging assets to the home loan banks in the Fed discount window. At the parent company, parent company liquidity was particularly strong at $125 billion, up $6 billion for the quarter. As you think about that increase, it's important to note that we accomplished that increase while reducing parent company debt by $17 billion during the fourth quarter.

As a result of those changes, our time to required funding increased to 29 months at the end of the year, up from 27 months at the end of the third quarter. That liquidity base, along with other funds that are available to us, will enable us to retire $60 billion of parent company unsecured debt that matures throughout 2012. About $24 billion of that is TLGP debt that will come due during the second quarter. As you think about our issuance plans throughout 2012, from a plain vanilla debt perspective, you should expect us to be issuing less long-term debt in 2012 than we did in 2011. Similar to where we were at the end of the third quarter, our parent company and broker dealers have no short-term unsecured debt outstanding.

If we move from liquidity to net interest income, turning to slide 10, net interest income was $11 billion during the fourth quarter, up $220 million from the third quarter. The increase was driven by lower asset hedge ineffectiveness, as well as less acceleration of amortization of premiums on securities. On the positive side, contributions to net interest income from lower debt balances and rates paid on deposits were more than offset by portfolio repricing and reduction in consumer loan balances, including the sale of the Canadian card business. I would ask you to keep in mind here that our asset liability management strategy is focused on managing interest rate risk across the entire corporation, which includes minimizing OCI exposure and managing the duration of our securities. Moving to slide 11, on deposits, we highlight the results of our deposits business.

Earnings for the quarter were $141 million, a decrease from the third quarter, primarily driven by an increase in FDIC expense, which we would expect to come down going forward. Average deposit balances decreased 1% compared to the third quarter, driven primarily by a decline in time deposits, which we had targeted to do during the quarter and will continue to do so. During the quarter, rates paid on deposits declined from 25 bps to 23 bps. As we continue to focus on the cost and optimize our delivery network, you can see our branch count came down again during the quarter. We have continued to expand our service for small business owners by hiring over 500 locally based small business bankers during the year to provide convenient access to financial advice and solutions to our customers.

We've also continued to increase our mobile banking customer base to 9.2 million customers, which is a 7% increase from the prior quarter and up 45% from a year ago. If we turn to slide 12, card services earnings decreased from the third quarter to $1 billion, primarily due to the impact of the Durbin Amendment, which kicked in during the fourth quarter. Credit card purchase volumes did increase by 6% from a year ago after adjusting for portfolio divestitures, and were up seasonally from the third quarter. Within our U.S. card business, new account growth was up more than 50% from the fourth quarter a year ago. Within card services, ending loans declined $1.6 billion from the third quarter, due largely to portfolio divestitures and continued non-core portfolio runoff that was partially offset by the increase in volume-related seasonal spend. Credit quality within the card business continues to improve.

U.S. credit card losses improved for the ninth consecutive quarter, and our 30-plus-day delinquency rate declined for the 11th consecutive quarter. As you look at the card business, I want to remind you that the international card business results were moved to all other in the third quarter, and prior period results were adjusted accordingly. Within Global Wealth and Investment Management, on slide 13, earnings for the quarter of $249 million were down from the third quarter, as lower market levels and activity drove lower revenue, and expenses were higher due to a few noisy items. Client balances were up 3.5% from the third quarter due to fourth quarter market levels, as well as AUM flows. Long-term AUM flows were $4.5 billion during the fourth quarter, pretty much in line with what we saw during the third quarter.

On the expense side, as I mentioned, there were several items, including higher FDIC and litigation expenses, as well as other related losses, and some severance costs that we saw during the quarter. We added 214 financial advisors to the world's leading advisory force during the quarter, with total FA levels exceeding 17,300 at the end of the year. As we look forward, we would expect muted advisor growth in 2012 based on economic conditions, as well as us absorbing the FA growth from 2011. Net income in Commercial Banking on slide 14 was flat at $1 billion. This is the third quarter. Commercial clients continued to increase liquidity positions, driving average deposit levels up $2.2 billion from the third quarter. Average loans were flat, as the reductions that we saw within our commercial real estate area were offset by about $1.7 billion of loan growth within the CNI category.

Asset quality continued to improve. Net charge-offs were down $83 million. Non-performing assets were down $1 billion to $5.6 billion, and our reservable utilized criticized exposure declined by 11% during the quarter. If we switch to our Global Banking and Markets area on slide 15, the results reflected increased sales and trading activity, excluding DVA, which I'll cover in greater detail in a minute. Average loan and lease balances during the quarter increased $10.5 billion, or 9%, primarily driven by growth in domestic and international corporate loans, as well as international trade finance. While deposit balances were down 5% versus the linked quarter, I would highlight that our ending deposits at the end of the year were up nicely, as we saw good flows during the last half of the quarter.

If you turn to slide 16, I'd ask you to look in the middle of the page where we've drawn a red box around our sales and trading area. Sales and trading, excluding DVA, was at $1.9 billion, or up 73% from what was a difficult third quarter, driven primarily by our fixed income currency and commodity area due to less volatility, a tightening spread environment, and a reduction in the CVA, although these are still at relatively elevated levels. Within our fixed business, excluding DVA, credit products, structured credit trading, and rates and currencies drove much of the increase. In equities, once again, excluding DVA, results decreased by 16%, primarily due to lower volumes and commission-related revenue.

We did record DVA losses, as I highlighted up front, of $474 million in the quarter, as our credit spreads tightened compared to gains of $1.7 billion that we saw during the third quarter. On the investment banking side, firm-wide investment banking fees, excluding self-led fees, were $1 billion, up 8% from the third quarter of 2011. We would also note here that we maintained our number two ranking globally in net investment banking fees while gaining share during the year. If we turn to slide 17, Consumer Real Estate Services reported a loss of $1.5 billion, driven by continued elevated credit costs in the home equity portfolio, higher litigation costs, and the cost of managing delinquent and defaulted loans in the servicing portfolio. The home loans business within the CREST area had a slight profit for the quarter.

First mortgage production of $22 billion was down from the third quarter, due primarily to our exit from the correspondent channel, which we spoke of during the last quarter's earnings call. As a result of this, core production income declined relative to the third quarter of 2011. Results for the quarter did include $263 million in costs for reps and warrants, primarily related to the GSEs, along with the $1.5 billion of litigation expense I touched on at the beginning of the presentation. Our MSR asset decreased by approximately $500 million during the quarter, driven by MSR sales and borrower payments, and ended the quarter at $7.4 billion. MSR results net of hedge were positive by approximately $1.2 billion in the fourth quarter. As we look at the cap rate on the MSR, we ended the period at 54 bps versus 52 bps in the third quarter.

On slide 18, we show some comparisons of certain metrics in the legacy asset servicing area on a linked quarter basis and compared to the prior year quarter, as we continue to work very hard to reduce delinquent loans and find homeowner solutions. As Brian referenced, we are either at or near the peak of staffing this area, and we are making very good progress. Total legacy asset services, firstly in servicing, dropped 16% in the quarter, while 60-day plus delinquent loans dropped 8%. Much of the work done to sell MSRs has allowed the transfer of more than 510,000 loans serviced in the past quarter alone.

As we look at this page, it's obviously very important that we continue to shrink the activity that we have in the legacy asset servicing area so that we can begin attacking the $2 billion of expenses that Brian alluded to at the beginning. On slide 19, we show you the results of all other, which recall includes our global principal investing business, the international consumer card business, strategic investments, our discretionary portfolio associated with interest rate protection, and the discontinued real estate portfolio. Items of note in the quarter in all other included $814 million related to the negative fair value adjustments on structured liabilities, the $581 million goodwill impairment charge related to European card, $2.9 billion related to CCB, $1.2 billion on the exchanges, and $1.1 billion related to the sale of debt securities.

As we move and split to slide 20, a lot of line items and data, but I would highlight a couple of things here. We did make very good progress across most categories of expense. If you start at the top line, you can see that our personnel expense did come down in the quarter, largely driven by a $7,000 reduction in FTE headcount from approximately 288,000 to 281,000. Those benefits were somewhat muted in the quarter due to higher default servicing costs and an increase in severance costs associated with the headcount reductions. You can see in the majority of the other line items that we did continue to reduce costs with several exceptions. The first in other general operating expense, which increased $1.6 billion.

That increase was due solely to an increase of $1.3 billion in litigation, as well as elevated FDIC expense, which we would expect to go down in 2012. The other two items of note, the $581 million goodwill impairment for the European consumer card business and our professional fees, which tend to be seasonally high during the fourth quarter of the year. If we turn to slide 21, let me update you with where we are with respect to our New BAC program. We completed the initial planning related to phase one in the third quarter of 2011 and began the implementation during the fourth quarter. Under our original guidance, we have a goal of achieving approximately $5 billion in cost savings, or about 18% of the expenses associated with the areas addressed.

We stated earlier that we were aiming for 20% of the $5 billion to be achieved during 2012. Based on the hard work done to date, we now believe we will exceed that 2012 goal. Phase two evaluations for the areas outlined on page 21 began late in 2011, and we would expect to complete that work in April. As we look at the expense base, it's similar to phase one, but we would expect lower cost savings given that the businesses tend to be more efficient already and have lower headcount. While the savings will be lower, we do think, however, that we will start being able to see some of those saves later this year as the initiatives to achieve the savings aren't as interdependent as the consumer businesses.

If we take a step back and look at the lower headcount from the third quarter and combine that with New BAC, both phase one and phase two, along with an improving mortgage environment, we believe we can realize substantial cost savings in the second half of this year. We're not going to identify a specific number on this call, but we'll update you as we move further into the year. If we now move to credit trends that we saw during the quarter on slide 22, you can see that overall consumer trends remain positive. Net charge-offs, 30+ performing delinquencies, and non-performing assets all continued to fall. Net charge-offs in the credit card area declined more than any other portfolio, due in part to recoveries recorded to the bulk sale of previously charged off UK credit card loans.

Provision expense in the consumer was $3.2 billion and included a $384 million reduction in reserves. On slide 23, you can see that residential mortgage and home equity 30 to 89-day performing delinquent loans, excluding our fully insured loans, were relatively flat with the third quarter. This was not unexpected as the fourth quarter has historically had slow collections. On slide 24, we show non-performing asset trends for both our residential mortgage and home equity area. Total consumer real estate non-performers trended down for the sixth quarter in a row. Residential mortgage declined from the third quarter as charge-offs, paydowns, and returns to performing status continue to outpace new non-accrual loans. Home equity loans did show a slight increase as inflows outpace charge-offs and returns to performing status.

The increase in NPAs was driven by growth in the greater than 180-day past-due loans, while the less than 180-day past-due loans remained flat as delinquency inflows remained relatively stable quarter over quarter. As you may recall, loans greater than 180 days past due have already been written down to their net realizable value. Turning to overall commercial credit quality on slide 25, the trends that we saw were very similar to what I referenced when I discussed the commercial bank. Including the provision for unfunded commitments, we recorded a benefit to provision expense of $220 million that included a reserve reduction of $736 million. Both non-performing asset and reservable criticized levels continued to decrease. If we flip to slide 26, we've included a slide on Basel III that we included when we reported our second quarter earnings, and I would make a couple of points here.

The first is we continue to work very hard as we work toward and progress towards Basel III at the end of 2012. You can see that significant progress in two different ways. The first, we had originally targeted getting our risk-weighted assets under Basel III down to $1.8 trillion by the end of 2012. We have updated that goal now to have risk-weighted assets down to $1.75 trillion. In addition to the reduction in risk-weighted assets based on the progress that we made during the quarter, we now expect our Tier 1 Common Equity Ratio under Basel III at the end of 2012 on a fully phased-in basis to be between 7.25% and 7.5%, up from our previous guidance of 6.75% to 7%. Let me now wrap up by spending a few moments discussing our expectations for 2012.

I won't go into a lot of detail as the economic landscape is somewhat uncertain given the evolving events in Europe, the upcoming elections, and the speed around the recovery in the housing markets. In 2012, we believe net interest income will remain somewhat challenged and will be highly dependent on the rate environment. While we expect consumer loans to continue to run off, this should be somewhat mitigated by loan growth in our commercial businesses. Additionally, we expect to benefit from continued reductions in the term debt footprint. Most of the line items in our earnings report, whether it be card income, service charges, investment, or brokerage, tend to be very correlated with the economy. If we see economic growth, we would expect that to translate into higher revenues.

At this point, Durbin is fully embedded in the fourth quarter results, so you have a solid base to work with there. Investment banking, we would expect activities in 2012 to be fairly consistent with what we saw in 2011. As Brian referenced at the beginning, we'd expect to see better results in sales and trading, but once again, those tend to be pretty correlated to global market conditions and the health of the recovery. Equity investment income, we'd expect to drop off considerably given the sale of the CCB shares that we had during 2011. On the expense side, in the first quarter, we should start to see the positive impact of the fourth quarter headcount reduction and the impact from New BAC.

Our goal for the fourth quarter of this year is to have sustainable cost savings, which would include not only certain New BAC, phase one and phase two benefits, but also lower expenses in LAS, the benefits of reduced merger charges, lower costs associated with businesses we've exited, as well as other expense reduction initiatives. Credit quality should continue to improve over the next few quarters, but at somewhat of a slower pace, and we'd also expect to continue to see some reserve reductions. Capital and capital ratios should continue to grow, and what will drive that growth in 2012 will be mainly through earnings and to a lesser extent RWA levels throughout the year. We expect that most sales of business units are essentially complete, although there will be some targeted activity within certain selected areas.

We expect the effective tax rate to be around 30% plus or minus, depending on any unusual items. In summary, as we enter 2012, we expect economic headwinds and low interest rates to persist while we continue to deal with legacy mortgage issues and ongoing regulatory changes. That being said, we enter 2012 with higher capital, liquidity, and combined reserves for credit, representations, and warranties, and litigation than at any point in the company's history. With that, why don't we go ahead and open up the line for questions?

Speaker 2

Certainly. At this time, if you wish to ask a question, you may do so by pressing the star and one on your touch-tone phone. That's star and one to ask a question. We'll go first to Mike Mayo with CLSA. Your line is open. Please go ahead.

Speaker 1

Good morning.

Speaker 4

Morning, Mike.

Speaker 1

Can you talk about the commercial loan growth and how much is due to drawdown of existing credit lines versus expansion in new areas?

Speaker 4

Let me just hit a couple of points. One of the things we traditionally talk about, Mike, is in our core middle market, because people look at that as a market for what middle market companies are doing in the draw rate. It is relatively consistent third quarter, fourth quarter, 32%, down 100 basis points from a year ago, I think, round numbers, and down maybe 800 or 900 basis points from where it would sit in a normalized economy. Middle market companies are consistently drawing but have not moved it. In a larger corporate area, we had some strong growth in the fourth quarter. I'll have Bruce touch on that. From a broad economy, people are fairly stable and sitting there. Bruce, why don't you touch on the higher?

Speaker 1

Sure. If you look at particularly within the Global Banking and Markets space, I would make a couple of observations. We saw growth in both regular way corporate loans as well as in the trade finance area. The growth that we saw was fairly widespread. If you look at that growth by region, we saw some growth in the U.S. and Canada, and we also saw a very nice growth in both Latin America as well as the Asia-Pac region. In addition to that, we also saw some growth within our mortgage area within the Global Banking and Markets area. Not any one thing was driving the growth. I'd say the one area that was probably the strongest was trade finance, but it was fairly widespread throughout the business.

Speaker 4

Mike, just one last observation. If you think about the capital markets-driven activity in the higher grade stuff, it's been very strong and non-investment grade comes in and out really on the markets. I'd say when I talk to sponsors and other people, they're ready to go. For deals, you know, $4 billion or $5 billion transactions, there's a very strong demand to do them from a sponsor side. I think if markets stay stable, we could see some pretty good activity this year on that. Go ahead.

Speaker 1

Yeah, no, just one separate and last question. For New BAC, are you cutting enough? I guess if you look at results for last year, you know, revenues reported were down $17 billion, expenses were down, you know, $3 billion. There is a big gap between the decline in revenues and decline in expenses. You can back out LAS and some other items. It still seems to be a pretty big negative gap. Are you cutting as much as you need to? You have the structural project, but perhaps more cutting for the cycle is needed?

Speaker 4

As we're approaching the business, which are more cyclical, i.e., in the trading businesses and investment banking, you've seen in the press that we've been, in advance, even doing the work in New BAC, we reduced headcount fairly significantly in some of those areas where the opportunities weren't there. That's more adjusting in that business cost two ways. One is the comp cost you adjust down, obviously, and then secondly, the headcount. That's been going on. I'd say you need to be, just to remind you, and you know this, Mike, there's negative revenue. The revenue warranty cost is actually negative revenue, so that has a fairly big impact. As we look at it, you know, we are driving towards the right cost structure for the right run rate of revenues. This company over time will continue to drive at that.

You could always say, could I go a little faster, go a little slower, but we need to balance, especially on the broad consumer business, the need to have good customer service, strong customer relationship, and continue to invest in the growth areas with getting the cost down. For example, on the branches, you've seen the numbers. We've dropped to 5,700 from a high of 6,100. Our cost of operating our whole retail platform as a % of deposits continues to work down. We have to be careful to make sure the service quality as we do that is well managed. It's a balancing act. I question every day whether we get it exactly right. Could you go a little faster, a little slower? The areas are really market sensitive. We move pretty quickly on cost.

The other areas, you have to be very careful and re-engineer the work so you make sure that you can still do a great job for the customers.

Speaker 1

Thank you.

Speaker 2

We'll take our next question from John McDonald with Sanford Bernstein. Your line is open. Please go ahead.

Speaker 1

Yes, hi. Good morning. Bruce, was wondering on net interest income. Was there still some level of asset hedge ineffectiveness and prepay amortization in the fourth quarter number? I know it was less than third, but was there something in the fourth?

There was, John. I think if you look at the delta in net interest income, really four main items I'll give you a little bit more detail on. We picked up $500 million of benefit during the quarter from less hedge ineffectiveness in prepays. We picked up $200 million to the positive based on lower debt footprint and our deposit pricing. On the negative side, we had about $200 million less because of the rates on our mortgage portfolio and about $200 million less due to the lower consumer card businesses, primarily credit card, which included the sale of Canadian card that we didn't have in December. If you take those four items, that'll give you the bridge, the change in net interest income for the quarter.

Do you think that you can grow net interest income from that level of $11 billion in the fourth quarter going forward? What's going to be the drivers?

I think, right now, if you look at what we've seen during the third and the fourth quarter, that's reflective of the balance sheet and the rate structure today. I think, as you look forward, the only things that are going to change those numbers going forward are primarily a change in interest rates and to the extent that we see any meaningful change in loan demand. As we look into 2012, I think that the third and the fourth quarters give you the best jumping-off point, realizing that there was still some hedge ineffectiveness in FAS 91 in those.

Okay, that's a good run rate. From there, it depends on whether rates rise and whether loan growth picks up.

That's correct.

Okay. Similarly on expenses, when we look at page 20, lots of details there. Trying to just get a sense of what the run rate might be going into the first quarter, taking out some of these specials, it looks like maybe something similar to last quarter, or $17.2 to $17.4 billion, something like that. I know you don't want to get too specific, but can you give us any kind of sense of where you might be entering the year with the expense base? I know you don't want to get specific about your targets, but where are you going to start off?

Yeah, I think that if you look at the recent quarters, it bounces around a little bit based on GBM revenues, GBM performance, compensation, and other things flowing through, as well as to the extent that there's severance or other things bouncing around. I think $17 billion area without any kind of one-timers or anything going through is probably the right starting point to think about, John.

Okay. From there, you expect to get the benefits in the second half from some of the LAS and the New BAC stuff. That should improve later on in the year from that base?

Yes. Remember, in that $17 billion type of number, Bruce is not eliminating the $2 billion of sort of core LAS operating costs. We expect to see that come down, and as I said in my comments, that come down and in the core run rate. We have to do this right, and that's where we keep engineering the change quarter by quarter by quarter. The headcount reduction this quarter was part of the start on. John, the only other thing I just want to make sure we highlight is, as we do each year in each first quarter, we have the vesting of the stock compensation expense during the first quarter. Recall that that was about $1 billion during the first quarter of 2011. I just don't want you to be surprised when you see that in the first quarter of 2012.

Okay. You were not including that when you said '17?

That's correct. I am not including that in the 2017. That's correct.

Okay. Last thing for me, just on the rep and warrant issue, Bruce, where do we stand on the changing GSE behavior? Is it more predictable? What was the nature of requests and denials that you got this quarter on the GSE front? Do you have a sense of how much of the GSE claims you've addressed? Thank you.

I think if you go back and look at the disclosure we have back in the slide, I would say at this point, we highlighted it in the third quarter that there were some disagreements between the two parties. I would say that there's really been no change in that perspective during the fourth. You can see that the GSE unsolved balance went up a little bit during the quarter, and quite frankly, that wasn't unexpected.

Okay.

Speaker 2

We will take our next question from Paul Miller with FBR Capital Markets. Your line is open. Please go ahead.

Speaker 0

Thank you very much. The $1.5 million litigation expense this quarter, and I know you guys have been putting a lot of money away for litigation, but is this related to the AG settlement, or is it just other various suits out there?

Speaker 1

What it relates to, I'd say there are two significant items that we would include, and I'm not going to quantify them. You saw that we did have the fair lending settlement at Legacy Countrywide prior to when Bank of America bought Countrywide that went through during the quarter. The second thing, you're correct. During the fourth quarter, while there's no DOJ AG settlement, you read what we read, and we adjusted our litigation expense as well as our reserve levels to reflect the best that we could our understanding of what the deal may be.

Speaker 0

Okay. The second question is asset quality. Charge-offs dropped $1 billion in the quarter, which I thought was a very good number. Was there some internal change? Are you pushing loans more through, or are you just working loans out better? Is there anything, any color around that number?

Speaker 1

Two things. The first is, and I referenced, is recall that we did sell during the quarter some of the loans in the UK that were written off. We did a little bit better than we could have expected, and that was about $300 million of the improvement. We did have that one-time pop or one-time benefit. I would say that across the board, on the consumer side, we adjusted the underwriting standards back in the fourth quarter of 2008 and the first quarter of 2009. We're starting to see the benefits from those standards as the old stuff has flown through and the new stuff is becoming a greater percentage of the portfolio. On the commercial side, I would say across the board, credit quality within the commercial space continues to be very strong. We continue to feel very good about commercial credit going forward.

The last thing I'd say is that we've obviously reduced the size of the commercial real estate and clearly think we're on the other side of the commercial real estate charge-offs.

Speaker 0

Okay. Thank you very much, gentlemen.

Speaker 2

We will go next to Glenn Schorr with Nomura. Your line is open. Please go ahead.

Speaker 3

Thanks very much. A couple of quickies. You mentioned in the outlook commentary that you think you could beat the 20% achieved for phase one. I'm just curious, bigger than a bread box, is that a lot more than the 20%, a little bit more than the 20%, and maybe where you're seeing the acceleration of that?

Speaker 1

We're the constant focus really going to the early comms to accelerate anything we can that really isn't dependent on technology implementation. When you look at the broad in 2012, we'll spend $750 million to get the cost phase type of numbers. We're trying to accelerate the non-technology dependent, and that's the reference we gave you. We're ahead of schedule, and we expect to stay ahead of schedule. Overall, the numbers will come in the goals we gave you.

Speaker 0

Okay, that's fine. Curious on what you have baked into both your credit loss assumptions and your reserves in terms of housing outlook. There's been some in the industry talking about bottoming. There's economic data that's getting better, there's affordability metrics that are getting better, but you still have distress inventory, the underwriting standards, and the securitization markets kind of frozen. Just general thoughts on housing bottoming and how you're positioned?

Speaker 1

Sure. Two things. The first on just credit across the company. What I would expect, and I just want to make sure that we're clear, we would expect charge-offs to continue to improve during 2012. At the same time, you're probably likely to see reserve releases slow down. From a net perspective, the jumping-off point at the fourth quarter is a pretty good jumping-off point as you think about credit for 2012. With respect to the housing piece of it, we look at and look out at macro markets and look at what the expectations are there as we look at forecasting and looking at residential real estate. Those basically show a flat market throughout 2012. As we project through 2012, we don't really assume any significant move up or down. It's basically flat.

From a true activity standpoint, we continue to see, you know, when we get hold of a property, we continue to be able to move it in 60 to 90 days. The activity is moving through the markets as the foreclosure rework was done and the activity. We don't try to outguess the market. We use sort of the average, and we adjust it for the places we have more loans. The reality is you continue to see the healing in the housing market every day in terms of the amount of activity, the amount of delinquencies, and the process moving forward. I think it's just still a lot of hard work, but you're seeing it move forward.

Speaker 0

Appreciate that. Sticking with the housing team, just curious if there's any update on the private label potential settlement and just maybe where are we in those conversations and maybe what's the next event timing-wise?

Speaker 1

Really, no change with anything that you see out there, which I think we're expecting to see by the end of February, the venue that the case will be decided. Basically, what you see out there is the same thing that we see. Our sense is we'll have a little bit better sense with where the venue is by the end of February.

Speaker 0

Is it Delaware versus New York? Is that the battle line?

Speaker 1

State versus federal.

Speaker 0

State-federal, sorry.

Speaker 1

Yeah, remember the decision.

Speaker 0

It got bumped up, that's right.

Speaker 1

Yeah, the decision's in the Second Circuit. Our expectation is somewhere in the next 45 days or so, they'll make a decision of whether it stays in federal court or goes to state court.

Speaker 0

Okay, last quickie is in the summary slide, you showed $5.6 billion of pre-tax pre-provision, but that's before a lot of the all these one-timers. There's a lot of moving parts, but curious if you have a thought on what a clean jumping-off point is for pre-tax pre-provision going into 2012 as we factor in your thoughts on expenses and we can make our own choices on the market.

Speaker 1

I mean, I think what I'd say is that the cleanest way to think about it is if you take the five, six, and you adjust for the items that are down below, you get to a number that's in and around four. As we look forward and as we look to build off of that four, you've obviously got a series of things that we'd look at going forward. We clearly would expect the trading and investment banking revenues to be better in 2012 than what we saw here. We've obviously got New BAC phase one that's beginning to kick in during 2012. As we've talked about, New BAC two will kick in quicker than one, probably towards the end of the year. You've got improvements towards the end of the year in the Legacy asset servicing cost.

Then you've got any improvement that we see from the rate environment. I think as you look at those numbers, that's probably the best jumping-off point. We're obviously working hard to drive those improvements with the categories that I just went through.

Speaker 0

Excellent. Thanks for all those answers.

Speaker 2

We will go next to Betsy Graseck with Morgan Stanley. Your line is open. Please go ahead.

Speaker 3

Hi, good morning.

Speaker 1

Morning, Betsy.

Speaker 3

A couple of questions. One on the housing. In the past, you have given the P&L hit of a, you know, 1% or 5% decline in home prices. I realize that your outlook is more stable. Given some of the changes that you've done in your business and asset sales, etc., I'm wondering how that number is, you know, that P&L hit has changed.

Speaker 1

Yep. We look at it, it hasn't changed that much, Betsy. Right now, we're looking at a 1% hit being about $450 million. That's comprised, you know, between $125 million and $150 million in our purchase credit impaired portfolio, about $200 million through reps and warrants, and about $125 million through the property values that get refreshed each quarter would be the way I think about it.

Speaker 3

Okay. You also gave a data point here on the servicing book and 8% decline in delinquent loan service. Can you give us an update on what portion of the total servicing book is delinquent?

Speaker 1

If you want, we can get to that. It's in the detail. I'll have Lee call you with it.

Speaker 3

Okay. Last on severance, did you break out what the severance dollars were in the quarter?

Speaker 1

We did not, but I can give those to you. We had about $186 million of severance during the third quarter, and that jumped up to about $239 million during the fourth quarter.

Speaker 3

Okay. Was that split between the different business lines, or how would I segment that between the business lines?

Speaker 1

Split between the business lines. The most significant piece you're going to see there is within the Global Banking and Markets area.

Speaker 3

Got it. Okay, great. Thanks.

Speaker 2

We'll go next to Brennan Hawkin with UBS. Your line is open. Please go ahead.

Speaker 0

Good morning, guys.

Speaker 1

Good morning.

Speaker 0

I was just hoping to get some more granular color on the improved Basel III guidance. Is the driver of that improvement there mostly the numerator improvement we saw this quarter? Can you give some color maybe on a contribution from an expansion in the RWA mitigation plans that you highlighted? Any chance for more detail there?

Speaker 1

Sure. I mean, I think if you think about, and the way that I would think about it is that there are a lot of pluses and minuses. If you go to page seven where we show you the balance sheet data, we show you that Tier 1 Common Equity has gone up by about $9 billion during the quarter. In addition to that, we've changed our guidance on the risk-weighted asset side by about $50 billion. I think if you take those two changes, realize we would have had some increase in our common equity in our original numbers flowing through the income statement, that if you look at those two line items and think about that in the context of $1.75 to $1.8 trillion, those are going to get you to about the 50 basis point increase in the guidance that we've given.

Speaker 0

Okay. Thinking about monoline exposure and the capital relief that we saw from another firm announcing a settlement, when you sort of back into the risk weights there, it implies maybe 600 to 700% risk weight for monoline exposure. Is it right to think about that sort of a risk weight for you guys? Do you get a similar risk weight when you think about your monoline exposure? Is that exposure limited to the $1.9 billion that you disclosed in the last Q plus that half billion in CVA?

Speaker 1

I think, you know, I can't speak to, and I saw the Morgan Stanley disclosure that I think you're referencing. I can't speak to exactly how they're doing it. What I can say is that if you look at, in our supplemental package, we show a breakout of our monoline exposure. We did take a couple hundred million dollars in the quarter of hits through the Global Banking and Markets area for monoline exposure. You can see at the end of the year, I believe back in the supplemental page, we show ourselves at about $1.3 billion of net exposure from a monoline perspective after CVA. Once again, we did take a couple hundred million dollars of expense during the fourth quarter.

Speaker 0

Is it right to think about it a risk weight that would be in the neighborhood of, you know, 700% on that exposure?

Speaker 1

Probably a little bit higher than that, quite frankly.

Speaker 0

Okay. Thanks.

Speaker 1

Remember the difference between our capital base size-wise and other people's capital base is one of the different effects here.

Speaker 0

Sure.

Speaker 1

We're dealing with $120 billion of Tier 1 Common, or, you know, so it's just a different type of number.

Speaker 0

Right. Proportionally different piece of the puzzle.

Speaker 1

Exactly.

Speaker 0

Thanks.

Speaker 2

We'll take our next question from Jefferson Harrelson with Keefe Bruyette & Woods. Your line is open. Please go ahead.

Speaker 1

Thanks. I was going to follow up on that kind of line of thought. When you think about the total risk-weighted assets shrinking $172 billion year over year or $75 billion quarter to quarter, can you just talk about what that is and what revenues are associated with that decline?

Sure. Let's go to the fourth quarter, I think, is probably the best place to start. If you start on page eight, let's just go through the individual items to give you a sense. The preferred exchanges, while we put the shares out there, there'll be a nominal P&L effect by virtue of having lower interest expense and lower preferred dividends. The CCB sale during the fourth quarter, as well as the one that we did in the third quarter, there have been some things written out there publicly about the impact that that's over $700.

Speaker 2

of a loss of revenues that go through. I think when you think about CCB, you have to think about the offset to that, which is by virtue of doing that, there was over $14 billion of liquidity that came into the parent company that basically will offset from an interest expense perspective the loss in preferred dividends that we would have had through that business. You move over to Canadian card, while the business clearly had PP&R associated with it, once you get down to the bottom line, from a net income perspective, the net income contribution of the Canadian card business was nominal. You continue to move through the right-hand side of page, net income at DTA is what it is.

The reductions in market risk, as you think about those reductions in market risk and work through that, roughly two-thirds of that reduction in market risk were certain assets that were legacy and other securitization type assets that we had targeted to sell that from a net income perspective didn't contribute that much. About one-third of the 21, or excuse me, one-third of the 18 basis points in market risk would have been, you know, would have been VAR and other things that tend to ebb and flow with market activity. To the extent that the markets get better in 2012, there could be 5 to 10 basis points that come back on there. Quite frankly, we would welcome that because it would be suggestive of the markets getting better. You then move over to the asset sales and changes in loans on a net basis.

The biggest piece of that is our runoff portfolio within the consumer businesses. The contribution from that runoff portfolio, once again, is very nominal. Lastly, you move over to 12 basis points of the other. Some of that is model related, some of it's measurement related, and I think some of it's just quite frankly us doing a better job as it relates to how we approach Basel I measurement. There were some offsets on the other side. As you go through this, the impact and to say that we're going to see any meaningful change in income based on what we did in the fourth quarter, we just don't see that recognizing that to the extent that the capital markets and the global markets come back, you may see a little bit of a bump up there.

Other than that, these are good numbers and there shouldn't be a significant revenue impact outside of what I just talked about.

Speaker 4

Right. Great. Thanks, guys. Yeah, just make sure there's revenue impacts, but after charge-off a lot of these portfolios, there's no bottom line. That's the thing I think it's not been as clear to people. Hopefully Bruce just clarified that for you.

Speaker 1

We'll go next to Nancy Bush with NAB Research LLC. Your line is open. Please go ahead.

Speaker 4

Good morning, guys.

Morning, Nancy.

Let me warn you in advance, it's a long question. The settlement with the AGs, which once again is rumored to be near. Brian, in your view, does this mark some, if we get this, will this mark some kind of watershed event that will lead to sort of a, you know, a quickening of the pace of the resolution of other issues out there?

I think in the work that's gone on to develop that settlement, you've had the major servicers and then obviously the representatives of the Department of Justice and the state AGs and HUD and others work together to come up with a package of programs that we believe will be very positive in pushing the situation forward. I think you're right. In hindsight, we'll decide whether it's watershed or not in a year from now, but I think the intent of those programs is to actually help drive the recovery in housing and how to handle customers. I think that combined with all the other programs and the million modifications we've done, that combined with, you know, whether you agree housing's up or down, but the general stability and frankly, you know, the passage of time and working through it, I think these are good things.

That's why we've wanted to, we and the rest of the industry have been trying to work this out really to provide that catalyst to keep pushing the mortgage situation forward. I think you're exactly right, Nan.

If we get this settlement and things start to resolve, does profitability at your company sort of go on some kind of stair step, you know, move up? Is there going to be some dramatic move upward as the housing issues get worked out? I mean, are legacy costs going to come down that quickly, you know, lessening of litigation reserves, et cetera, et cetera? I mean, is there going to be some point at which there is a big change in profitability at Bank of America?

I mean, if you just, the question is, is how fast does it come through? Just to implement the settlement and the work will take a series of months and quarters. I think the theme is exactly right. If you think about the drag in 2011, we made a few billion dollars in the fourth quarter, we had a $1.5 billion loss in our consumer real estate business. For the year, we made a billion dollars in plus and we had substantial losses in the real estate business, as you can see. If you take those losses out, the core run rate of the company is embedded and is running every quarter. The business we had, they're performing or driving profit. This has been a huge drag for this company, both from an expense side and then a charge-off side and everything else. It will come that way.

I just cautioned Nancy to realize that this is a lot of work, a lot of people, and a lot of particularly difficult because of what's involved in people and their homes and stuff that we've got to work through, right? I just caution on the speed, but the principle's right.

Okay. Just a question for you, Bruce, you mentioned a reduction in FDIC expenses in 2012. Can you quantify that or give us some color about what the expenses were in 4Q and how they should step down?

Speaker 2

Yeah, I would think about it as that as we got through the fourth quarter, there was a true up, and as we go forward, we'd expect that expense to be down a couple hundred million dollars in the first quarter relative to the fourth quarter.

Speaker 4

All right, thank you.

Speaker 1

We will go next to Ed Najarian with ISI Group. Your line is open. Please go ahead.

Okay, thanks. Good morning.

Speaker 4

Morning, Ed.

Speaker 1

You talked about the LAS costs coming down, and you broke that $3.5 billion down into, you know, sort of $1.5 billion of litigation and $2 billion core. Can you give us any sense of what you think sort of a long-term run rate or normalized level is for that $2 billion core? I know you're probably reluctant to talk about the timing of getting there, but when you do get there, maybe even, you know, two years away, what would be the right number to think about that $2 billion going to?

Speaker 4

I think, Ed, to frame that, I think about the 60+ delinquent units and the progress we made this year and the progress we ultimately got to get to a more normal, quote, normalized level. That will take the next, you know, six, eight quarters to get through that. When you get down to that level, the number should be more in a $300 million a quarter versus a $2 billion from the operating cost side. A reasonable amount to service those loans, even under the heightened servicing duties that will be embedded in the way you service delinquent loans going forward, is that kind of number. I just again say it's going to take us time to work through that. You see the progress we made this year.

You see the flows coming in, flowing because of the whole servicing portfolio in terms of improving delinquency and then moving the stuff through the process. I think that's what you're looking for from a $2 billion down to maybe a $300 million a quarter type of number.

Speaker 1

Okay, thanks, that's helpful. The second question would be on, you know, interest-bearing deposits. Unlike other banks, we saw, you know, a pretty big step down in interest-bearing deposits. I know some of that was probably intentional CD runoff, but it really happened in most deposit categories. Any color on that? In your mind, did that have anything to do with sort of the snafu around the charge related to debit cards that you then took back?

Speaker 4

Let's start from the broad strokes. We saw an elevated level of account closings in the quarter, elevated from last year fourth quarter, but frankly, by say 20% versus last year fourth quarter 10 to 11, but from nine, it's actually still down in the fourth quarter of 2011 versus fourth quarter of 2009 by 20% odd. You saw that, so there's no question, that's why we pulled it back. Once we pulled it back, you saw that mitigate. That will carry us into the first quarter. From a deposit strategy, just remember overall a couple of things. One is if you look at our deposit pricing, we have been very conservative as rates have stayed low to make sure that we continue to bring that pricing down. In the retail world, we're down to 20% odd basis points.

If you look even in the high net worth world, we're down in that pricing. What we've made the decision was to have our customers, you can see in some of the short-term flows, use the off-balance sheet vehicles and things like that as opposed to on-balance sheets. That was a strategy also. There's a third part of this, which is our balance sheet financing construct with a billion and a trillion plus in deposits with the amount of equity we have is that our banks are extremely liquid. Taking wholesale-oriented deposits, both domestically and internationally, we've been just cutting that back dramatically. If you look in the fourth quarter, there's about a $20 billion deposit reduction that was engineered off of foreign time deposits and things like that that overwhelms the good core activities in the businesses really because we just, we can't use the liquidity.

It was, we're in a sense at our bank level because liquidity is so strong. As we're downsizing assets, we're creating more of it. It's a negative carry. You can see our overall liquidity numbers, time to acquire funding is going up while we're reducing the aggregate amount of deposits from this more funding characteristic. I'd say that yes, we had some impact from the $5 debit fee. That's why we made the decision to reverse it. Those impacts in the scheme of things will be manageable. More importantly, the real deposit phenomena is we're seeing growth. There's no question as we saw the second half of the quarter, more stability around the market, the company we saw it kick up even the corporate side. The real engineering deposits have been both general rate conservatism, i.e.

making sure we're making money for the shareholders and doing a good job to customers, but more importantly on the more wholesale stuff, sort of bringing it down because frankly, we can't put the money to work right now.

Speaker 1

Okay, thanks. That's helpful. Finally, you know, about $21 billion of government insured mortgages that are 90 days past due. I think the whole analyst community is wondering what the risk around the guarantees on that are. I know that question has been asked on a lot of calls to a lot of companies and it's just sort of everyone's answer is, they're guaranteed. Do you have any more color around that risk other than just sort of saying, we think the guarantees are there?

Speaker 2

I think the only thing I would say that is really just further supportive of that is that a fairly healthy chunk of the guarantees are from product that was purchased from correspondence. When it's purchased from the correspondence, it's wrapped by the government guarantee at that point. We feel very good about the fact that it's wrapped. That was the basis on a significant chunk of those, that the wrap was around them when we purchased it. We clearly haven't seen anything that would suggest any differently.

Speaker 1

You're not getting any feedback from the FHA or from any other kind of government entities that those guarantees could be at risk, in conjunction with any kind of servicing issues that might be happening on those particular loans?

Speaker 2

No, I think we do continue to work through the servicing piece of that with the FHA to make sure that we're in conformance with their standards when we go through the foreclosure process. That is separate and distinct from the fact that those mortgages have the FHA guarantee.

Speaker 1

Okay, thank you very much.

We'll take our next question from Matt O'Connor with Deutsche Bank. Your line is open. Please go ahead.

Speaker 4

Good morning.

Speaker 1

Morning, Matt.

Speaker 4

If I could just follow up on the expenses, you've given a lot of color in terms of the initiatives and the puts and takes. As we think about the full year, I guess you've got $17 billion run rate, $1 billion of stock expense in Q1, and then just how quickly does the $17 billion come down throughout the year? Obviously the capital markets is a wild card, but maybe you can just help frame what expenses will look like for the rest of the year as well.

Speaker 2

You know, I think you would expect to see more of it in the second half largely because the Legacy asset servicing piece, as we can see, the rate of working it down comes through. I think it's the severance cost and stuff to help offset sort of the incremental quarter-to-quarter move. I'd say we've got plans to bring it down over the course of the year. It's because of the 123R expense in the first quarter, the reported number would not be much, but you'd see sort of that core run rate go down almost link quarter, quarter, quarter, quarter, quarter, but it'll be a little more back-end loaded just because the Legacy asset servicing piece takes us getting through the, remember we got the foreclosure look back, which costs us $20 million a month or more in there.

You got some other things that you got to get through to get to the other side of it.

Speaker 4

Okay. In terms of magnitude, any numbers you could put, like where you think you might be on a run rate basis by the end of 2012?

Speaker 2

Matt, I don't think we'd answer that one too.

Speaker 4

Okay. In the mortgage business, you had some MSR gains, I think about $1.2 billion or so. How much of that was from hedging? It seems like that might have included gains on selling MSRs, which helps in multiple ways. If you could just split out the hedge gains versus the gain on sale.

Speaker 2

Yeah, I'd say a couple of things. If you think about the MSR, when we went into the fourth quarter, we continually look at and look to balance where interest rates are, where mortgage rates are, and what declines in interest rates will do relative to mortgage prepays. With rates very low in the fourth quarter, we lightened up a little bit on the hedge ratio. Rates obviously went back up, and we benefited from that. The other thing I would say is that as we looked at and saw actual prepay speeds during the fourth quarter based on the interest rate assumptions, the prepayments were not coming in as quickly as we would have expected. We adjusted our models to reflect that. As you think about those two numbers, I'd think about the $1.2 billion being split about 50-50 between the two.

Speaker 4

Okay. I guess the sales of some MSRs was not meaningful in terms of.

Speaker 2

No, I mean, sometimes you lose a few bucks, sometimes you make a few bucks, but what we've seen is that the sales that have happened have been generally consistent with where we're marked. Obviously, the real benefit, and I go back to the slide that we show that we track the number of loans and delinquencies, the goal is to continue to shrink the LAS business as quickly as possible so we can get at the expense. That's really what the MSR sales accomplish, not so much any real gain.

Speaker 4

I guess taking that to the next level, you've exited or are winding down the correspondent business, but obviously you still have all the loans serviced and therefore the MSR. Is there an opportunity to offload that portfolio, which would help the Basel III capital by a decent amount?

Speaker 2

Yeah, I'd say across the board, we continue to be aggressive in looking to move the MSRs. I think if you look at it, we're starting to see more people bring these kinds of packages to the market. We feel good that we got out in front of this early in that we moved a significant amount of MSRs. The other thing that you referenced to keep in mind is that we've reduced, over the course of the last six months, our MSR as we look forward to Basel III, is down over $5 billion. It had been up around $12 billion or over $12 billion, and we're now in the mid sevens. We're continuing to work that down.

I don't think you should expect to see as much sale activity over the next couple of quarters as what we saw close in the fourth quarter because a lot of what closed in the fourth quarter were things that were signed up in the third.

Speaker 4

Do you think it's possible? I mean, a lot of the big banks are trying to reduce the MSRs because of the Basel III restrictions. I mean, are the policymakers sensitive that if all the big banks are getting out of MSRs, there's not really enough capacity to absorb it all? That could increase the cost of home ownership and mortgage rates and everything.

Speaker 2

I don't think it's appropriate for me to comment on what the policymakers are saying. I do think that the one thing that's interesting is that obviously the large servicers have certain standards that are prescribed by the different bank regulators that we've signed up for as part of the consent decree. Obviously, a lot of these sales do go to people that are not subject to that same regulation and scrutiny. I think going forward, it will be interesting to see how that landscape evolves.

Speaker 4

Okay, thank you very much.

Speaker 1

We'll go next to the side of Chris Kotowski with Oppenheimer & Company. Your line is open. Please go ahead.

Speaker 0

Yeah, just in the supplement, looking at the segment disclosure for Global Banking and Markets, the allocated capital and economic capital is down like, you know, 30% to 40% year over year. Allocated capital down from $47 billion to $33 billion, economic capital from $37 billion to $23 billion. I guess two-part question. Part one is somehow that doesn't seem to sync with the actual reduction in risk-weighted assets yet that we've seen. I mean, why is the capital going down so much more if the risk-weighted assets aren't kind of going down in tandem? Secondly, I guess the question is if you look at that economic capital there of $23 billion, is that enough capital to run a world-class investment bank, you know, given that JPMorgan allocates $40 billion and Morgan Stanley has $40 billion of tangible common and Goldman has $60 billion?

Speaker 4

I think you're now comparing a lot of different things because there's other operations that are supportive, whether that's Goldman or Morgan Stanley, but we have a consistent methodology. As the legacy assets have gone out from an economic capital cost, that has been a very efficient, for lack of a better term, reduction. The RWA may be under Basel I, may be, you know, 100% risk-weighted or things, but we have an economic analysis that we look in the risk embedded in that. As you get to Basel II and III, those three things come in sync, as you know. The equities come down. Let me be clear. If this unit wanted more capital, we would give them more capital. I think Bruce was clear about that. Whether it's their value at risk or whether it's their capital, this is really due to the opportunities and things going on.

There are drivers in the credit quality that's improved dramatically over the last four quarters in the unit. There are drivers from the legacy assets, think of things in there from, you know, the model line positions we talked about, the auction rate notes we talked about, the CDO positions being liquidated and taken out. On top of that, as they brought risk down because the opportunities aren't there to do it, we expect that risk, the good core risk, the risk we want, to go back up. As Bruce said, five, seven basis points of capital would be great because implied in that would be making money as opposed to losing money on the trading side. Don't think that this is an outcome of a model that we run all the time and run it consistently as opposed to a limit on our capital or anything like that.

Speaker 2

If you look at the decrease, the one thing we disclosed in the second quarter that you have to keep in mind is that the Bank of America Merchant Services business was moved from the Global Banking and Markets business to the commercial business. At the time that it was moved, it was over $5 billion of value. That's pure equity. A significant piece, you're right, that came down was by virtue of a business being moved, not necessarily what was actually going on within the trading businesses.

Speaker 0

Okay. If I guess going, both looking back over the past year and looking forward, you know, if you look at the risk-weighted asset mitigation, can you break that up into how much of that is just getting rid of legacy assets that no longer support a, you know, any current business purpose versus actually, you know, trimming back the capital lines to the various trading desks?

Speaker 2

I think I tried to address that when we spoke to the reductions in market risk during the fourth quarter, when we talked about two-thirds of it within the market risk being from getting rid of certain positions, including the securitization as well as some of the structured credit. Once again, I think about that market risk number being two-thirds stuff that we wanted to be done with. One-third, there were less opportunities. Like I said, hopefully, and you know, so far, the first couple of weeks in January, we have seen more opportunities. If that number could come back, but two-thirds of that should be gone.

Speaker 0

Okay, thanks. That's all for me.

Speaker 1

We'll take our next question from Matthew Deyoe with Wells Fargo Securities. Your line is open. Please go ahead.

Speaker 3

Good morning. I just wanted to follow up on Bruce's comments on the MSR. I understand what you're saying about what appears to be an MSR hedge benefit in the quarter. I'm just curious, in an interest rate declining environment, to write up the MSR seems a little counterintuitive, particularly given that a couple of your competitors and the more larger competitors in the mortgage business didn't do that. As a follow-up on that, if you end up getting the AG settlement or the industry ends up getting the AG settlement that's rumored to be near, do you think that will require you and other industry participants to materially write down your MSRs from that specific event?

Speaker 2

Two things. We don't see the industry settlement affecting the MSRs. The second thing with respect to the MSR valuation, I'd make a couple of points. The first is that while rates did decrease, the prepayment activity that we saw relative to expectations was less. The second thing I think you have to keep in mind is that our MSR went from 52 to 54 basis points during the quarter, which is significantly lower than all of our peers. If you look at the remainder of our peers, generally people either wrote it up or wrote it down within a 5 basis point window during the fourth quarter. I think we were very consistent with what we saw, but importantly, as far as the capitalization rate, we're the lowest in the industry.

Speaker 3

Okay. If I could, just a question on Europe. It looks like your exposure to the peripheral countries really didn't change very much, quarter over quarter, from your disclosure. I guess I'm just curious as to some of the recent trends that have occurred since the beginning of the year, if that's made you feel a little bit more sanguine about what's going on in Europe and if that is flowing through your view of sales and trading and other opportunities for Bank of America this year.

Speaker 2

Yeah. I think you asked an interesting question. I think if you think about what we've talked about the last couple of quarters, that we moved fairly aggressively within the Global Banking and Markets area in 2010 to be positioned to where we wanted to be in Europe. I think got out ahead of it very early. Your point is exactly right, which is we look at our company and our results, that the single largest thing or how we're affected by what goes on in Europe is the activity levels that we see within our Global Banking and Markets area here in the U.S. Your point, I think, is a good one that obviously in November and December, given the volatility, were very difficult. The new issue market slowed down and it was tougher to trade.

As we've seen some of the programs and at least some of the resolution that's happened over the course of the last couple of weeks, if you look out into the fixed income markets, they've picked up significantly. The IPO backlog, if there's a market, is significant. If you look at the loan business, we're seeing good flows there. We're only two and a half weeks into the year, but clearly some of what's happened in Europe and how people are feeling better there has manifested itself into stronger capital markets and sales and trading during the first part of this year.

Speaker 3

Just one final question. Could you update us on the status of the European card portfolio sale? If you were to sell that, what your expectation is in terms of the Tier 1 Common benefit?

Speaker 2

I think, you know, if you look at the aggregate of the portfolio, it's about $15 billion in risk-weighted assets. The only thing I'd say at this point is that we continue to look good to go through the process. Outcomes are stating the obvious. We may do nothing. We could look at all of it or there could be a piece of it that goes. As we go through this process, given the capital and liquidity that we have, we're going to make what makes sense and just not sell something for the sake of selling it.

Speaker 3

Okay, thank you very much.

Speaker 1

We will take our final question from Andrew Marcart with Evercore. Your line is open. Please go ahead.

Speaker 3

Morning, guys.

Speaker 4

Morning.

Speaker 3

I want to ask about capital and the upcoming CCAR process. It seems like based on your commentary that this year will be focused on capital build and expense control. Is it safe to assume that, again, you will not be asking for any deployment for 2012?

Speaker 4

Yeah, to be clear with you, we're not going to ask to make sure that we're well positioned in Basel III, so your assumption is correct.

Speaker 3

Okay, thanks. In terms of the upping of your capital target on a Basel III basis by the end of this year, does that kind of show the confidence that you have in terms of not only your earnings and the risk-weighted assets coming down, but that there's more room to go and that you can really show and prove kind of a roadmap to being in Basel III compliance through this process as well so that there's no additional actions that might need to be taken?

Speaker 2

Yeah, I'd say two things. I think increasing the guidance first is reflective of the work that we did this quarter and how we accelerated the capital build. Once again, if you go back to the balance sheet side, you can see that we increased our Basel I capital, our common equity by $9 billion. You should assume that the Basel III number was very close to that. I think that the first thing is that raising the guidance in large part was reflective of how we accelerated the actions that we did during the fourth quarter. The second thing to your point, obviously bringing down the amount of risk-weighted assets that we would think we have at the end of 2012 is reflective of your comment. The third thing I would say is that we've had this capital team together now for the better part of the year.

I think I would say we're very pleased with how the team's working. The more you get into this, the more you tend to find. We're working very hard to drive that forward.

Speaker 4

Yeah, I'd say that the other thing, moving past 12 and beyond, you have to remember that we have been working for the last couple of years to think about, as Basel III became clear, intent and into 11 and the CFP and all the stuff became clear. You know, we had to be thinking long-term about how you keep positioning a company. If you think about the three major deducts from the numerator, financial institutions, stakes, PMSR, and DTA, we've done a lot of work on two of those. The DTA will come down as we earn. There's leverage in that past 12 and out into before the deducts become effective. There's leverage in that. If you look at it as Bruce ran through the denominator, the piece that Andrew, the people have to keep in mind is that this doesn't stop in 12/31/20. The process goes on.

There are portfolios like the runoff portfolio and the credit books. There was a high at 120, the down round number is now at 90, runs about $4 billion or $5 billion a quarter, will continue to run over that time period. There are things like the structured credit trading book. There are other ways to optimize beyond that. What we're getting as we do the work that Bruce said and the work we've done in the last couple of years is attacking the biggest things first, but there's a lot of, for lack of a better term, smaller things that you just keep working on, working on. A lot of which is not core to what we do day to day. That's what we've been pushing through. You should expect us to continue to manage this as we have and continue to drive it forward.

Speaker 3

Got it. It sounds like there are still some ticky-tack mitigation to go, but nothing major. It sounds like one shouldn't be concerned about, you know, kind of a major kind of action in response to the CCAR stress test.

Speaker 4

Right. We have one more question, I think.

Speaker 3

Yep. Just to pile onto the many questions on expenses, I just want to be clear. You know, expense leverage, there is some this year, but obviously top line is going to be more muted and mixed. Do you need to have the capital markets businesses recover before you get positive operating leverage this year, or is there enough expense leverage to get there regardless?

Speaker 4

I think if you look at in the last couple of quarters, if you break out the GBAM and you can see in the revenue, the corporate banking profit there is really fairly stable and moves along. You know, we lost $400 million after tax in that business this quarter. You know, we need that business to come back or we got to do more on expenses. We’ve taken some expenses down. I think that that, but coming back from just the third quarter, the fourth quarter, taking out all DBA, you saw the results recover even in another difficult quarter. Coming back doesn't mean back to some level that it was at the high point in the first quarter or 10 or something like that. Coming back means, you know, $3.5, $4 billion of revenue and we start making money.

That's a lot of leverage in the platform because, you know, effectively between $2.5, $2.75 billion, you are under pressure to make, that's where you kind of break even and start making money as a practical sense on a pure trading side. We need that, but if we don't get it, we'd have to go to the other side. That's what this New BAC2 process is working on is what is sort of the right, for lack of a better term, fixed cost structure, even though a lot of it's variable for comp, but what is the right fixed cost structure given what we see in the market conditions and opportunities. We moved early on just sort of the marginal, get it down, get some people, get some expenses down, but then more fundamentally, how do we reset the base?

We do need that to get some of the positive operating leverage. The rest of the businesses, you look at the consumer side and stuff, they've been ground down by the revenue changes and now we got to grind, you know, move forward from there. If you look at the businesses, whether it's Wealth Management, whether it's Global Commercial Banking, whether it's card, you know, you can see those businesses performing well and they'll keep clicking along. It's really fixing mortgage, getting it back to profitability, getting trading back to profitability and starting to build off of a $150 million base in retail.

Speaker 3

Great. Thank you.

Speaker 4

One more question, I think we have.

Speaker 1

We'll take our final question from Moshe Orenbuch with Credit Suisse. Your line is open. Please go ahead.

Speaker 2

Great. Thanks a lot. Actually, part of what I was going to ask Brian was about the mitigation results post 2012 because that's something you have spoken about before. In terms of on the mortgage side, just going back to that for a second, in the reps and warranties, you mentioned that no significant change or no unexpected change from the GSEs. You did note a little bit of a build in the amount of unprocessed claims, and yet you brought the reserve down. What is it actually that you saw that allowed you to bring the reserve down? Was it kind of passage through more of the book? How should we think about that?

Speaker 4

If you think about the reserve, the reason that the reserve comes down is that because to the extent that you settle up and pay things that you believe that you've owed, it comes out of the reserve and the reserve comes down. I think the other thing I'd say is that, as we said, we had a $250 million, $275 million of rep and warrant expense. The reserve coming down was reflective of paying those things that were expected and accrued for. Obviously, we had a couple hundred million of expense over and above that.

Speaker 3

Yeah. Moshe, remember this is a little different than other things you can think about in a P&L and a financial service company in that there is really a sealed book of 2004, 2005, 2006, 2007, 2008 originations that you're working against. The expectation is as you provide it for all the activity you expect to see out of that whole pool, you're going to work this reserve down every quarter because you're using it to pay for stuff that you calculate in your expectations. It's different than credit or other stuff in that that's the expected outcome because it's a sealed book. When you look at the originations from 2009, 2004, and 2010, the delinquencies in our portfolios, as Bruce Thompson said earlier, are much better than you would have expected when you're originating in 2009.

At the end of the day, if the loan doesn't ever become delinquent, we don't talk, this isn't a problem. The quality of the origination practices and the products themselves, et cetera. This is really 2004, 2008, really 2004, 2007, quite frankly, sealed bid. On the private label side, the private label market stopped in 2008. You really are looking at a sealed group of loans and that's why you'd expect the reserves to come down. Agreed, as there's more impasse, we are consistently applying a standard of resolving. If people are more aggressive on what they put to us, there'll be more impasse and we'll deal with it over time.

Speaker 2

Okay. Just a follow-up on the AG settlement. Obviously, one of the things they've talked about a lot is principal reduction. How do you think about that as it relates to current rate of charge-offs, the amount that's sitting in your reserve, and the prospect of charge-offs? How do you think a change there is going to impact those items?

Speaker 4

We've been doing this, we've been doing principal reductions for a number of years now. The thing is, it all is based on a situation that the assessment is the net present value from that is better than the alternative, which would be to foreclose and take it through for the investors. I think that is a clear determinant of what the better value is, and that's the basis of how you make the determination. I think it's overall, as I said before, I think reaching a solution here would be a positive, because as Nancy talked about earlier, it is a rational set of criteria to get to these issues.

Speaker 2

I just want to be clear, I referenced it earlier, the reserves and where we are at year-end with respect to the credit reserves within the mortgage business are reflective of our expectations from what we know now of what comes out of the DOJ AG settlement.

Speaker 4

Great. Thanks very much.

Speaker 2

Great. Thank you, everybody.

Speaker 1

This concludes today's conference. You may disconnect at this time. Thank you and have a good day.