Correction: Fitch Upgrades Bank of America's VR to 'a'; Outlook Revised to Stable
Fitch Ratings has upgraded Bank of America's (BAC) Viability Rating (VR) to 'a' from 'a-'. At the same time, the agency has affirmed BAC's Long-Term and Short-Term Issuer-Default Ratings (IDRs) at 'A' and 'F1', respectively. The Rating Outlooks for the Long-Term IDRs are Stable.
BAC's Long-Term IDR is now driven by its VR, which has been upgraded to 'a' from 'a-'. The upgrade of BAC's material legal operating subsidiaries' IDRs to one notch above their VRs reflects the expected implementation of total loss absorbing capital (TLAC) requirements for U.S. Global Systemically Important Banks (G-SIBs) and the presence of a substantial debt buffer in the holding company.
A full list of rating actions follows at the end of this rating action commentary.
The rating actions are in conjunction with Fitch's review of sovereign support for banks globally, which the agency announced in March 2014. In line with its expectations announced in March last year and communicated regularly since then, Fitch believes legislative, regulatory and policy initiatives have substantially reduced the likelihood of sovereign support for U.S., Swiss and European Union commercial banks. At the same time, Fitch has taken into account progress with the U.S. single point of entry (SPE) resolution regime and TLAC implementation for U.S. G-SIBs.
Fitch believes that, in line with our Support Rating (SR) definition of '5', extraordinary external support while possible can no longer be relied upon for BAC or its subsidiaries. Fitch has, therefore, downgraded their Support Ratings (SR) to '5' from '1' and revised their Support Rating Floors (SRF) to 'No Floor' from 'A'.
The upgrade of BAC's VR is driven by the maintenance of good capital and liquidity levels, materially lower looming litigation costs than at any point over the last few years, as well as the company's slowly improving earnings profile.
The ratings actions are also part of a periodic portfolio review of the Global Trading and Universal Banks (GTUBs), which comprise 12 large and globally active banking groups. A strong rebound in earnings from securities businesses in 1Q15 is a reminder of the upside potential banks with leading market shares can enjoy. However, regulatory headwinds remain strong, with ever higher capital requirements, costs of continuous infrastructure upgrades and a focus on conduct risks.
As capital and leverage requirements evolve, GTUBs are reviewing the balance of their securities operations with other businesses and adapting their business models to provide the most capital platforms for the future. Fitch expects the GTUBs' other core businesses, including retail and corporate banking, wealth and asset management, to perform well as economic growth, which the agency expects to be strongest in the U.S. and UK, will underpin revenue. However, pressure on revenue generation in a low-interest environment is likely to persist, particularly in Europe, but low loan impairment charges in domestic markets should help operating profitability.
KEY RATING DRIVERS - IDRs, VR AND SENIOR DEBT
The upgrade of BAC's VR is driven by the maintenance of good capital and liquidity levels, materially lower looming litigation costs than at any point over the last few years, as well as the company's slowly improving earnings profile.
It is this latter point, which Fitch believes has the most weight in warranting the upgrade of the VR. Fitch believes that now that the bulk of BAC's large legal settlements are behind it, the strength of BAC's suite of core franchises will slowly become more evident.
Fitch believes that BAC's management has done a good job resolving the company's large litigation exposures as well as beginning to streamline the company's operations, which at first was through the company's 'New BAC' initiatives and more recently through its ongoing 'Simplify and Improve' program.
Fitch thinks there is still ample room for BAC to improve its sustainable earnings power through cost reductions and other efficiency initiatives.
Chief among these opportunities is continuing to reduce costs from the company's Legacy Assets & Servicing (LAS) segment as more and more of BAC's problem assets are resolved or sold. The main cost reduction benefit here will be through reduced headcount in the LAS segment.
In its core on-going operations, Fitch would expect BAC to continue to optimize overall branch network through branch closures, the rolling out of reformatted branches, as well as headcount reductions across its branch banking platform.
Fitch would also expect BAC to continue to rationalize its overall staffing levels by utilizing technology more efficiently, reducing redundant operations, and simplifying its business processes.
To the extent that management is successful in this effort -- which Fitch has already observed some positive results -- the company's efficiency ratio (non-interest expenses divided by total revenues), and Fitch believes it could drop from the low 70 percentage range to the high 60 percentage range over a longer-term time horizon.
Furthermore, to the extent that this potential efficiency ratio improvement is sustainable it could push BAC's Fitch calculated adjusted pre-tax ROA consistently above 1.00% (it was 0.89% in 1Q15), and therefore much closer to peer averages.
When Fitch also considers that now that management is more focused on driving the business than dealing with legacy issues, BAC's revenue growth should also improve, which could also help boost the company's returns over a medium term time horizon.
Finally, to the extent that short-term interest rates eventually rise BAC may get a stronger earnings benefit than peers given its proportionately larger retail deposit base than peers.
Fitch would expect retail checking and savings deposits -- the bulk of BAC's funding profile -- to re-price more slowly than other forms of funding in a rising Short-Term interest rate scenario. This should provide a stronger boost to the net interest margin of firms like BAC, with proportionately larger amounts of retail deposits, than other peer institutions.
To the extent that BAC is able to generate incremental revenue through either of the avenues described above, Fitch believes it's likely to further improve the efficiency ratio (revenue is the denominator in the efficiency ratio), and therefore BAC's overall earnings profile.
The VRs remain equalized between BAC and its material operating subsidiaries. The common VR of BAC and its operating companies reflects the correlated performance, or failure rate between the BAC and these subsidiaries. Fitch takes a group view on the credit profile from a failure perspective, while the IDR reflects each entity's non-performance (default) risk on senior debt. Fitch believes that the likelihood of failure is roughly equivalent, while the default risk given at the operating company would be lower given TLAC. All U.S. bank subsidiaries carry a common VR, regardless of size, as U.S. banks are cross-guaranteed under the Financial Institutions Reform, Recovery, and Enforcement Act (FIRREA).
The Long-Term IDRs for the material U.S. operating entities are one notch above BAC's to reflect Fitch's belief that the U.S. single point of entry (SPE) resolution regime, the likely implementation of total loss absorbing capital (TLAC) requirements for U.S. G-SIBs, and the presence of substantial holding company debt reduces the default risk of domestic operating subsidiaries' senior liabilities relative to holding company senior debt. In Fitch's views these buffers would provide substantial protection to senior unsecured obligations in the domestic operating entities in the event of group resolution, as they could be used to absorb losses and recapitalize operating companies. Therefore, substantial holding company debt reduces the likelihood of default on operating company senior obligations. As at end-2014, BAC had hybrid and senior debt as a percent of risk-weighted assets (RWA) of greater than 20%, more than its Pillar 1 capital requirement.
The 'F1+' Short-Term IDRs of BAC's bank subsidiaries is at the higher of two potential Short-Term IDRs mapping to an 'A+' Long-Term IDR on Fitch's rating scale to reflect substantial liquidity at the banks and typically higher core deposit funding, further liquidity resources at BAC that could be extended to the bank and access to further contingent liquidity sources such as Federal Home Loan Bank advances. BAC and its non-bank operating companies Short-Term IDRs at 'F1' reflect Fitch's view that there is less surplus liquidity at these entities than at the bank, particularly given their greater reliance on the holding company for liquidity.
KEY RATING SENSITIVITIES - IDRs, VR AND SENIOR DEBT
With the upgrade of BAC's VR, Fitch sees limited downside to BAC's ratings and notes that the company's ratings are likely near the lower-end of their potential range.
Further upside to BAC's VR would likely be predicated on continuing to improve the company's earnings performance such that BAC's returns consistently exceed those of peers as well as the company's cost of equity, which Fitch estimates to be approximately 12%, over an extended period.
Fitch notes that this would likely require BAC to sustainably improve its efficiency ratio to the mid-to-high 50's through some of both the cost reduction initiatives and revenue growth opportunities described above.
Should management be unable to achieve these targets over a longer-term time horizon, it is likely that ratings would remain at current levels.
Downside risks to ratings, while not expected, include any remaining litigation exposures or other unforeseen charges that result in a significant net earnings loss, or if the company's regulatory or tangible capital ratios begin to meaningfully decline.
Additionally, should BAC's overall credit quality materially deteriorate over the near term, or the company experience a severe and unexpected risk management failure this could also negatively impact the VR.
KEY RATING DRIVERS AND SENSITIVITIES - SUPPORT RATING AND SUPPORT RATING FLOOR
The SR and SRF reflect Fitch's view that senior creditors can no longer rely on receiving full extraordinary support from the sovereign in the event that BAC becomes non-viable. In Fitch's view, implementation of the Dodd Frank Orderly Liquidation Authority legislation is now sufficiently progressed to provide a framework for resolving banks that is likely to require holding company senior creditors participating in losses, if necessary, instead of or ahead of the company receiving sovereign support.
Any upward revision to the SR and SRF would be contingent on a positive change in the U.S.'s propensity to support its banks. While not impossible, this is highly unlikely in Fitch's view.
KEY RATING DRIVERS AND SENSITIVITIES - SUBORDINATED DEBT AND OTHER HYBRID SECURITIES
Subordinated debt and other hybrid capital issued by BAC are all notched down from the common VR in accordance with Fitch's assessment of each instrument's respective non-performance and relative loss severity risk profiles, which vary considerably. Subordinated debt issued by the operating companies is rated at the same level as subordinated debt issued by BAC reflecting the potential for subordinated creditors in the operating companies to be exposed to loss ahead of senior creditors in BAC. This is also supported by the FSB's proposal to have internal TLAC rank senior to regulatory capital at the operating company. Their ratings are primarily sensitive to any change in the common VR. They have, therefore, been upgraded due to the upgrade of the common VR.
KEY RATING DRIVERS AND SENSITIVITIES - DEPOSIT RATINGS
The upgrade of Bank of America N.A's deposit ratings is based on the upgrade of its IDR. Deposit ratings are one notch higher than senior debt reflecting the deposits' superior recovery prospects in case of default given depositor preference in the U.S. BAC's international subsidiaries' deposit ratings are at the same level as their senior debt ratings because their preferential status is less clear and disclosure concerning dually payable deposits makes it difficult to determine if they are eligible for U.S. depositor preference.
MATERIAL INTERNATIONAL SUBSIDIARIES KEY RATING DRIVERS AND SENSITIVITIES
Merrill Lynch International (MLI), Merrill Lynch International Bank Ltd (MLIB), and Bank of America Merrill Lynch International Limited are wholly owned subsidiaries of BAC whose IDRs and debt ratings are aligned with BAC's because of their core strategic role in and integration into the BAC group. Fitch has revised the Rating Outlook for BAC's material international operating companies' IDRs to Positive. The revision is in light of the internal pre-positioning required under the Financial Stability Board's (FSB) TLAC proposal. The Positive Outlook reflects the agency's belief that the internal TLAC of material international operating companies will likely be large enough to meet Pillar 1 capital requirements and will then be sufficient to recapitalize them. A one notch upgrade is likely once Fitch has sufficient clarity on additional disclosure on the pre-positioning of internal TLAC and its sufficiency in size to cover a default of senior operating company liabilities. Sufficient clarity may, however, take longer to come through than the typical Outlook horizon of one to two years
MLI and MLIB's ratings are sensitive to the same factors that might drive a change in BAC's IDRs.
OTHER SUBSIDIARY KEY RATING DRIVERS AND SENSITIVITIES
Non-material legal entities IDRs and debt ratings are aligned with the ratings of BAC.
Those domestic subsidiaries and international subsidiaries that have not been upgraded or placed on Rating Outlook Positive are in Fitch's opinion not sufficiently material to benefit from domestic support from BAC or are international subsidiaries that would not benefit from internal TLAC.
Fitch has taken the following rating actions:
Bank of America Corporation
--Long-Term IDR affirmed at 'A'; Outlook Stable from Outlook Negative;
--Long-Term senior debt affirmed at 'A';
--Long-Term subordinated debt upgraded to 'A-' from 'BBB+';
--Long-Term market linked securities affirmed at 'A emr';
--Senior shelf affirmed at 'A';
--Short-Term IDR affirmed at 'F1';
--Short-Term debt affirmed at 'F1';
--Viability Rating upgraded to 'a' from 'a-';
--Preferred stock upgraded to 'BB+' from 'BB';
--Support downgraded to '5' from '1';
--Support floor revised to 'NF' from 'A'.
Bank of America N.A.
--Long-Term IDR upgraded to 'A+' from 'A'; Outlook to Stable from Outlook Negative;
--Long-Term senior debt upgraded to 'A+' from 'A';
--Long-Term subordinated debt upgraded to 'A-' from 'BBB+';
--Short-Term IDR affirmed at 'F1';
--Short-Term debt affirmed at 'F1';
--Long-Term deposit rating upgraded to 'AA-' from 'A+';
--Short-Term deposits upgraded to 'F1+' from 'F1';
--Viability Rating upgraded to 'a' from 'a-';
--Support downgraded to '5' from '1';
--Support floor revised to 'NF' from 'A'.
Bank of America California, National Association
--Long-Term IDR upgraded to 'A+' from 'A'; Outlook to Stable from Negative;
--Short-Term IDR affirmed at 'F1';
--Viability Rating upgraded to 'a' from 'a-';
--Support downgraded to '5' from '1';
--Support floor revised to 'NF' from 'A'.
Merrill Lynch & Co., Inc.
--Long-Term senior debt affirmed at 'A';
--Long-Term market linked notes affirmed at 'A emr';
--Long-Term subordinated debt upgraded to 'A-' from 'BBB+';
--Short-Term debt affirmed at to 'F1';
Merrill Lynch, Pierce, Fenner & Smith, Inc.
--Long-Term IDR upgraded to 'A+' from 'A'; Outlook to Stable from Negative;
--Short-Term IDR affirmed at 'F1'.
Bank of America Merrill Lynch International Limited
--Long-Term IDR affirmed at 'A'; Outlook to Positive from Negative;
--Short-Term IDR affirmed at 'F1'.
B of A Issuance B.V.
--Long-Term IDR affirmed at 'A'; Outlook to Stable from Negative;
--Long-Term senior debt affirmed at 'A';
--Long-Term subordinated debt upgraded to 'A-' from 'BBB+';
--Support affirmed at '1'.
Secured Asset Finance Company B.V.
--Senior debt affirmed at 'A'.
Secured Asset Finance Company LLC
--Senior debt affirmed at 'A'.
BofA Canada Bank
--Long-Term IDR affirmed at 'A'; Outlook to Stable from Negative;
--Long-Term senior debt affirmed at 'A';
--Long-Term subordinated debt upgraded to 'A-' from 'BBB+';
--Short-Term IDR affirmed at 'F1'.
MBNA Limited
--Long-Term IDR affirmed at 'A-'; Outlook to Stable from Negative;
--Short-Term IDR affirmed at 'F1'
--Support affirmed at to '1'.
Merrill Lynch International
--Long-Term IDR affirmed at 'A'; Outlook to Positive from Negative;
--Short-Term IDR affirmed at 'F1';
--Support affirmed at '1'.
Merrill Lynch International Bank Ltd.
--Long-Term IDR affirmed at 'A'; Outlook to Positive from Negative;
--Short-Term IDR affirmed at 'F1';
--Support affirmed at '1'.
Merrill Lynch B.V.
--Long-Term IDR affirmed at 'A'; Outlook to Stable from Negative;
--Long-Term senior debt affirmed at 'A';
--Long-Term market linked securities affirmed at 'A emr';
--Support affirmed at '1'.
Merrill Lynch & Co., Canada Ltd.
--Short-Term IDR affirmed at 'F1';
--Short-Term debt affirmed at 'F1'.
BAC Canada Finance
--Long-Term IDR affirmed at 'A'; Outlook to Stable from Negative;
--Long-Term senior debt affirmed at 'A';
--Short-Term IDR at 'F1';
--Support affirmed at '1'.
Merrill Lynch Japan Finance GK.
--Long-Term IDR affirmed at 'A'; Outlook to Stable from Negative;
--Long-Term senior debt affirmed at 'A';
--Short-Term IDR affirmed at 'F1';
--Short-Term debt affirmed at 'F1';
--Support affirmed at '1'.
Merrill Lynch Japan Securities Co., Ltd.
--Long-Term IDR affirmed at 'A'; Outlook to Stable from Negative;
--Short-Term IDR affirmed at 'F1';
--Support affirmed at '1'.
Merrill Lynch S.A.
--Long-Term market linked securities affirmed at 'A emr'.
Countrywide Financial Corp.
--Long-Term senior debt affirmed at 'A';
--Long-Term subordinated debt upgraded to 'A-' from 'BBB+'.
Countrywide Home Loans, Inc.
--Long-Term senior debt affirmed at 'A';
--Long-Term senior shelf unsecured rating affirmed at 'A';
FleetBoston Financial Corp
--Long-Term subordinated debt upgraded to 'A-' from 'BBB+'.
LaSalle Funding LLC
--Long-Term senior debt affirmed at 'A';
MBNA Corp.
--Long-Term senior debt affirmed at 'A';
--Long-Term subordinated debt upgraded to 'A-' from 'BBB+';
--Short-Term debt affirmed at 'F1'.
NationsBank Corp
--Long-Term senior shelf debt affirmed at 'A';
--Long-Term senior debt affirmed at 'A';
--Long-Term subordinated debt upgraded to 'A-' from 'BBB+'.
NCNB, Inc.
--Long-Term subordinated debt upgraded to 'A-' from 'BBB+'.
BAC Capital Trust VI-VIII
BAC Capital Trust XI - XV
--Trust preferred securities upgraded to 'BBB-' from 'BB+'.
BAC AAH Capital Funding LLC I - VII
BAC AAH Capital Funding LLC IX - XIII
--Trust preferred securities upgraded to 'BBB-' from 'BB+'.
BankAmerica Capital III
BankBoston Capital Trust III-IV
Barnett Capital Trust III
Countrywide Capital III, IV, V
Fleet Capital Trust V
MBNA Capital B
NB Capital Trust III
--Trust preferred securities upgraded to 'BBB-' from 'BB+'.
Merrill Lynch Preferred Capital Trust III, IV, and V
Merrill Lynch Capital Trust I, II and III
--Trust preferred securities upgraded to 'BBB-' from 'BB+'.
Fitch withdraws the following ratings:
Fitch is withdrawing its ratings because they are no longer considered by Fitch to be relevant for our rating coverage, because the entities no longer exist.
BankAmerica Corporation
--Long-Term senior debt at 'A';
--Long-Term subordinated debt at 'BBB+'
Countrywide Bank FSB
--Long-Term Deposits at 'A+';
--Short-Term Deposits at 'F1';
LaSalle Bank N.A.
LaSalle Bank Midwest N.A.
--Long-Term Deposits at 'A+';
--Short-Term Deposits at 'F1'.
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