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Bank of America Corporation (NYSE:BAC)

August 10, 2011 1:00 pm ET

Executives

Brian Moynihan - Chief Executive Officer, President, Director and Member of Executive Committee

Bruce Berkowitz - Founder and Portfolio Manager

Bruce Thompson - Chief Financial officer

Analysts

James Sinegal - Morningstar Inc.

Rajat Jain - Litman/Gregory Research, Inc.

James Mahoney - The Daily Oil Bulletin

Operator

Good afternoon. My name is Michelle, and I will be your conference operator today. At this time, I would like to welcome everyone to the Fairholme Conference Call with Brian Moynihan, Chief Executive Officer of Bank of America. Moderating today's call is Bruce Berkowitz of Fairholme Capital Management. Before we begin, please note this call will last 1.5 hours and is being recorded. Once the conference call has been concluded, please refer to www.fairholmefunds.com for a transcript and a replay of the call.

Let me remind you that today's discussion may contain some forward-looking statements by Bank of America regarding its financial condition and its 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 Bank of America's SEC documents. [Operator Instructions] Thank you. Mr. Berkowitz, you may begin your conference.

Bruce Berkowitz

Well, thank you. I'd like to begin by thanking all participants and the Bank of America team, Brian Moynihan and staff, for doing the call. We're going to start the call. We have a lot to do, so we're going to start quickly. We're going to start the call, ask Brian to give us updates about Bank of America since the earnings call. Once that's done, I will ask Brian the toughest questions that were frequently asked during our e-mail process. Once that is finished, we'll open up the call for the remainder of the time allotted.

So with that, thank you, Brian, for joining, and please begin.

Brian Moynihan

Thank you, Bruce. I have Bruce Thompson here, our Chief Financial Officer is here with me, as well as Lee McEntire, one of our senior executives of Investor Relations. We set this call up about a month ago, and it's hard to imagine, when we set it up, it was going to be the market volatility we've all seen with the various activities that have taken place in the last couple of weeks. So we are glad to have a chance to answer your questions today and talk to you, Bruce, and your shareholders about the company.

Before we begin, I just wanted to make sure that we left you with the 3 or 4 points that are key about what we're going to talk about today. Number one, our core franchise continues to perform in the market, is growing market share in its core businesses. When we look at our array of businesses, they are the strongest positions that anybody has across businesses or consumers, companies and institutional investors.

The second point is we continue to execute on a broad scale transformation of this company. We do that through focusing on the core strategic customer basis, selling noncore assets, and that helps our focus and also generates capital, and moving from product sales to customer-focused execution in each of our businesses.

The third point is our capital levels are among the highest they've ever been in this institution's history. They're sufficient to run the company even after we took $20 billion in the second quarter, which Bruce will discuss later, to help with the mortgages issues behind us. We have a clear path on implementing the new rules under Basel III, the new banking regulatory capital rules. We're going to execute on that path, and that path involves a continued transformation of the balance sheet of the company.

The fourth point is the focus on the key issues we're managing through. Those issues are obviously continuing to clean up the mortgage issues related to the Countrywide acquisition, get our operating cost down across the board, and that has to be especially true on the tough revenue and extended low interest rate environment, which isn't that favorable to some of the core banking activities, and to continue to lower the risk in our company across the board.

Before I jump in, I'd like to say a few words about what we're seeing in the economy, which I think people may be interested in. As we look at our consumers in 1 or 2 households, we have millions of debit and credit card holders. And each month, we look at what they spend on and how they spend their money. In the month of July 2011, those consumers spent about $37 billion on their cards, 5% more than they spent in July 2010. This shows that the core customer base continues to push along, consumers are continuing to spend money, maybe not as fast as people have projected, but this is about the 15th to 16th month of continued increases.

Gas prices contributed about 1.5% to 2% of that growth. The rest is core spending growth. Credit demand across our portfolios continues to be slow, but credit risk continues to improve. And we've seen the trends of improved charge-offs and delinquencies that we saw in the second quarter of 2011 continue in July.

Now in the market side. The market continues to reflect tremendous uncertainty in demand for products and economic growth prospects for companies and economies, uncertainty about the debt burdens of the U.S. and other nations and the overall macroeconomic factors here and around the world. The equities and markets continue to reflect that concern. We can see it everyday on our screens.

However, if you think about it, the fundamentals are so much better in our country and in our company and in our industry than they were 4 years ago when last the financial crisis hit. There's a lot less leverage, whether it's for consumers' leverage, companies' leverage, leverage in the financial system and leverage across the world.

The recent statements regarding the prospects for American growth, as the background of which, all of us in our industry and we, in particular, have to manage our company. We expect that as the market continues to show, that this is going to be a slow and steady but grinding recovery. That's going to have steady, low interest rates. But it continues to move forward, and we have to continue to manage through it.

Before we talk a little about the specifics of how we did in the second quarter in the franchise, let's take a look at the last 1.5 years. If you think back where we started when I took over on January 1 last year, in 2010, we've just come off an aggressive acquisition phase and the financial crisis. And in the acquisition phase between 2006 and 2008, the company bought MBNA, U.S. Trust, La Salle, Countrywide and Merrill Lynch.

Just to give you a point of reference. Post-Merrill Lynch, the combined Bank of America Merrill Lynch on 1/1/09 had $70 billion of tangible common equity, $1.7 trillion of risk-weighted assets and total assets of about $2.5 trillion. Today, we have $128 billion in tangible common equity, $1.4 trillion in risk-weighted assets and $2.2 trillion in total assets.

Simply put, we have twice the capital we did back then. But as I took over in 2010, I had to focus on how we built that capital. Still on capital during 2009, we had to incur dilution. We issued over 3 billion shares and brought our share count to over $10 billion -- 10 billion shares. Even after that substantial dilution, we began 2010 with a tangible common equity ratio of about 5% and a Tier 1 common ratio under Basel I of about 7%. These ratios were not sufficient even with the 50% more shares outstanding. We simply cannot continue on the course of diluting our shareholders to build capital. So as I said, our #1 priority is to transform the company and its balance sheet, to rebuild that balance sheet to be able to support growth, navigate through a cycle that would come someday without a dilution and, frankly, align the franchise to the core strategic customer-focused businesses. We had to bring down risk across the board in our consumer portfolios, our commercial estate portfolios and our trading risk. So we started on an asset transformation.

Our first priority is to set a clear customer-focused strategy. We serve 3 groups of customers in our company: consumers from those individuals to the wealthiest people in the world, companies from the smallest companies to largest companies in the world and institutional investors. We sell them the core products, and we have top tier positions to do that. Our second priority was to shed noncore assets. A priority which continues today, and we'll continue to work on through the balance of the next couple of years. The third was to continue to transform the balance sheet in terms of assets, equity and the reserve position. And the fourth was to focus on driving returns outside the balance sheet from that balance sheet.

The continued focus on long-term shareholder growth remains in this company, and we believe a key to that is to focus on tangible book value per share growth. That's the measure which translates over time to strong shareholder returns. So how do we make all those improvements and how do we make that transformation happen? To do that, we sold 23 units in 6 quarters. We've built reserves for the mortgage issues from a negative amount at the beginning of that time period to over $18 billion. And on top of that, we have litigation reserves. We've driven down credit risk, so that charge-off coverage ratio increased from 1x trailing charge-offs to 1.6x.

In January 2010, we set a capital goal of 5.5% to 6% of tangible common equity for our company. Why was that level important? But what we've done and looked at was everybody who had that level or more, survived this crisis and survived the past crisis. In addition, it matched and exceeded our internal models or risk models for capital requirements. Today, we are at 5.87% tangible common equity. We have achieved this goal, and that ratio will continue to improve for us to meet the regulatory capital rules I spoke about earlier.

At the same time, we set a regulatory capital goal of Tier 1 common of 8.5% to 9% in the Basel I. We're at 8.23%. And now we need to continue to improve. The new rules, which we adopted, caused us to redouble our efforts to grow regulatory capital ratios and to ultimately achieve by 2019, when the rules are fully effective, a Tier 1 common ratio of 9.5%. In addition, during this time frame, we informally focused on growing our tangible book value per share, and that grew from $11.30 to $12.65, and that's the investment you have in us worth 12%.

We've also dramatically reduced the risk in the franchise. We have moved our profit trading off the company's. This completely could have all the positions are sold [ph]. We're not doing any acquisitions. We completed the last third or fourth in the process of finally completing the last transitions of Merrill Lynch. We sold $20 billion of equity investments. We significantly tightened the underwriting standards on the consumer side, reducing unsecured consumer book from $225 billion to $150 billion, and that will continue to serve us well in the slow economic recovery.

Our commercial real estate book is down from $80 billion, as peak, to $40 billion. Our legacy asset market assets left over financial crisis are down materially. This work is and will continue to be the massive transformation to continue to build capital and focus the company. So where that left us was more capital, more reserves, both credit- and mortgage-related, less risk and, most importantly, more tangible book value per share.

So what is ahead? Ahead is a continued focus on this franchise, continue to drive that core customer business, which we're all heavily invested in and second to none. What is also ahead is aggressive selling of noncore assets to continue to generate capital, increase our focus and lower risk. But also ahead is the continued optimization of the risk to drive down the risk-weighted assets under the new rules. And what also is ahead is to accelerate expense management and streamline the company, that I'll discuss in a few minutes.

But before that, there's been some debate about selling core assets and why would we not prioritize that. Because of many reasons -- but let me just give a few. First, the customers want us to provide all the services we provide: the corporation to be able to provide corporate investment banking advice to them, an individual to be able to provide both banking and brokerage and investing advice to them. That's what the customers need and want, a corporation that can serve them in the United States and outside the United States. That's the customer-driven franchise we built. The second reason is sale of core assets would hurt that franchise. But more importantly, it's also where we earn the bulk of our money right now. And third, when you have encore assets to sell, why would you sell the core assets.

As I spoke about before, we're also focused on the reality of managing in a protracted economic recovery that's going slower than people predicted even earlier this year. And that means cost management. It's not surprising that post-Merrill Lynch and post-financial crisis, there's a lot of inefficiencies we've built for the company, even setting aside the legacy asset servicing business, which solely deals with the delinquent mortgage loans and has 40,000 people working on that on a given day.

We've been taking expense out of areas during the year. For example, from our origination side of the Mortgage business, we've taken almost 4,000 positions out this year. All that's in an effort to build the expenses to continue to support the areas of growth for the company, whether it's in international area, growing our financial advisors, growing small business relationship managers or other internal growth. Core expenses have been running about flat.

But that's not enough. So 3 minutes ago, we started on a company-wide campaign called New BAC to begin to take out significant expenses from the company. That effort continues to work and will come to fruition as we go past Labor Day. It's a significant bottoms-up approach to realigning our company against customer-focused strategy. It will produce significant cost savings and generate a better experience for our customers and employees. We'll give you more detail in our third quarter earnings call, but suffice to say, the savings will both be material and substantial based on our work to date.

The other thing we continue to focus on is the mortgage cleanup. Obviously, there aren't many days that I get up and think positively about the Countrywide transaction in 2008. In each quarter, we continue to put risk behind us. In the past quarter, we made a significant step forward in doing that. The mortgage area will continue to make noises and get through the current legal cases, but the risk has been lowered each quarter for the last 3 and the quarters before that.

So as we think about what we have done in transformation, increased the focus, lowered the risk, managed expenses, the key is to focus on what we have that no one else has, and that's the best franchise in the business. Our greatest asset is this franchise that's been built over 230 years. It's operating on a customer-focused strategy on an integrated basis that provides powerful results. This type of investment quality has not been seen before, and we're focused on leveraging that, and we'll continue to do that.

So as you think about our franchise in the second quarter, let's talk about what happened. The core franchise continues to perform. In the second quarter, all of our businesses made money. They made a total of $5.7 billion [ph] . But when you added the mortgage charge, we produced a loss. So overall, we lost $0.90 a share, but we made $0.33 excluding those charges. Returns on all of the operating businesses, except for mortgage, were above our cost of capital. But we still have work to do to get these businesses to the operating levels we'd like, and we still have lots of work to do to continue to fix our mortgage business.

When you think about the specific businesses, our consumer deposits business, which we have been strategically repositioning from a product sale group to a customer relation group, grew net checking accounts for the second straight quarter. Deposits grew in the second quarter. The rates paid to the customers fell in the quarter, but cost to operate the franchise fell in the quarter. In this business, we've seen the impacts of the overdraft regulations and other changes fully based into the run rate so the service charges are stable and beginning to grow.

We also shed in the quarter 63 less productive branches as we continue to fine-tune the retail deposit franchise on our way to our goal of eliminating 750 branches over the next few years. Our broad coverage banking centers in the markets around the U.S. enables us to continue to right-size the network while there's a continuing to build the cash density of distribution we have.

We move from our Deposits business to our Credit Card business that's also recovered from the credit issues. We made over $2 billion in the Credit Card business, and that was aided by reserve releases. Importantly, we added over 750,000 accounts for the quarter, another solid quarter of new accounts. Credit quality of this underwriting remains very, very strong. We've seen credit improvement in both delinquencies and charge-offs in the second quarter, and we saw a further improvement in July.

Our Global Wealth and Investment Management businesses, Merrill Lynch Wealth Management and U.S. Trust continue to produce solid results with more than $500 million of after-tax profit. In those businesses, we added advisors. The client balances continue to grow on the second quarter, and we'll continue to drive the connectivity of these businesses throughout our franchise. When we go to our goal of Commercial business, our Middle Market business and Commercial Real Estate businesses, we had strong earnings in the quarter of $1.4 billion after tax. These businesses recovered fully and continue to have solid and good deposit growth, stable loan balances and good efficiency.

Our Global Banking and Markets businesses, our large corporate investment banking and trading businesses earned $1.6 billion after tax in the quarter. Our investment outside the U.S. continues to bear fruit as our loans in our investment banking fees outside the U.S. were at record levels for us. And in fact, our loans to large corporations outside United States, our funded loans are bigger than our loans inside the United States. Our Investment Banking team finished second in the world of fees received with about $1.6 billion, and our trading business made money on 97% of trading days and had solid results.

So as you think about it from the top of the house, credit in the second quarter continued to improve, and our reserve shows strong coverage at 1.6x our annualized charge-offs. Delinquencies and charge-offs continued to improve trends, which you see across the board continue in July. Even with new unemployment claims stagnating early in the spring were getting worse, we have seen consistent improvement in unsecured consumer books, a testament to the underwriting changes we made several years ago and was also what gives us confidence as economy slows that, that does not impede our progress forward.

Loan growth remains muted except internationally, as I spoke about before. We continue to run off the noncore portfolio, which has dragged our earnings out the charge-offs. But that reduction of portfolio releases capital. Deposits were strong in the second quarter and moved well over $1 trillion. Our cost of bond of those deposits continues to be driven down each quarter. And during July, we continued to see strong deposit growth.

Our margins will continue to -- as we stated last year in the second quarter, will continue to be under pressure as the interest rate environment goes forward. And we've been clear about that we think we've hit a plateau there, and we'll continue to work to improve that. Expenses for the quarter were flat on a core basis, subtracting out the mortgage charges. But that's clearly not good enough. We continued to absorb large expenses to clean up our legacy assets. We've seen the headcount generally take over on the company, and our New BAC program is well underway to provide significant expense leverage beginning later this year and in 2012 and beyond.

However, while we manage expenses, we continue to invest in those international capabilities I spoke about, continue to add financial advisors and small business lenders and we continue to integrate our systems capabilities. So our franchise continues to perform, and we've been positioning to even continue to perform in a slower economic recovery.

So now let's turn to the 2 issues which are on your mind. I'll have Bruce speak a few minutes on these. The 2 issues are mortgage risk and capital. On Mortgage, we've continued to work to encapsulate risk, take risk off the table and put it behind us. On rep-and-warranty putback risk, each of the last 3 quarters, we've made major steps. Over the past several quarters, we built the reserves over $18 billion plus in rep-and-warranty liability reserves and also -- and more in litigation reserves.

On the operations side of the Mortgage, one of the more encouraging things is that we saw during the quarter, we're able to reduce the number of delinquent customers by about 150,000 mortgage holders. That's on a base of about 1.5 million. We're seeing states, particularly nonjudicial states, with large banking [ph] , and we continue to make progress so that if we can't modify customer's loan, we take them through the process and move forward, as we need to do.

So I'd ask Bruce to cover some specific provisions we took in the second quarter of Mortgage, I'm sure which you'd have questions about later. Bruce?

Bruce Thompson

Great. Thank you, Brian, and good afternoon. As Brian mentioned, we have established significant reserves during the last several years, and I'd like to give you a few examples of those.

If you look at our overall loan reserves for credit losses at the end of June, they totaled $37.3 billion, which, to put in context, represents 1.64x our annualized charge-offs, as well as 4% of our total loan and lease balances.

Let me move to mortgage within the credit loss area because we tend to receive a lot of questions on that. If you look at our loan loss reserves within the mortgage business at the end of June, they totaled $21 billion. To put that in context, that's 2.5% of our total residential mortgage loans, and the piece that we allocate for Home Equity is nearly 7% of a reserve relative to our total Home Equity balances, excluding purchase credit impaired.

As you think about those reserve coverages, I think it's very important to note and keep in mind how our mortgage assets are carried on our balance sheet. Once a mortgage loan goes more than 180 days past delinquent, it is charged down to the net realizable value. And as we go forward, we update that net realizable value on a quarterly basis.

In addition to our credit reserves, we have approximately $18 billion in reserves in our mortgage business for rep-and-warrants, and we have additional reserves for litigation matters. The rep-and-warrant liability of approximately $18 billion at the end of June compares to only $4 billion that was on our books at the beginning of 2010.

Our 10-Q filing disclosure regarding our GSE rep-and-warrant liability created a lot of questions. We want to be very clear on this. We have accrued a liability at June 30 for the GSEs based on the behavior that we saw during the second quarter as it relates to putbacks of mortgages. We have not seen any material change in that behavior since the end of June.

I would also like to make one additional comment on the balance sheet and our how it relates to capital. We have a mortgage servicing right on the balance sheet, $12.4 billion at June 30 of 2011. Under Basel III, a portion of this is deducted from Tier 1 common capital. As we have said previously, we're working aggressively to reduce this and recently signed an agreement to sell approximately $500 million of certain mortgage servicing rights. We continue to work on additional sales as we move forward, as well as focusing on reducing the level of MSR that we originate on the front end within our mortgage business.

And with that, I'll turn it back to Brian.

Brian Moynihan

Thanks, Bruce. To hit the second major topic, let's talk a little bit about capital. We've been clear and we'll remain clear. That capital targets, we believe those capital targets are the right targets to run our company by, and we've got -- still have a road to cross in terms of optimizing our capital through regulatory rules. So as I said, we set goals of 5.5% to 6% tangible common equity, and we're at 5.87%. We're at 8.23% Tier 1 common, and this ratio will improve. Both these ratio improved during the quarter, but we have work to do to continue to optimize as we look forward to Basel II -- Basel III. We'll continue to build that capital quickly as we earn money from the core businesses, continue to optimize the franchise, not only from this position of noncore assets reducing risk and also optimizing RWA. So I'd ask Bruce to make a few statements on capital, and then we'll summarize and take your questions.

Bruce Thompson

I think Brian spent some time walking through how we think about the capital, how we think about risk. I'm going to touch on capital as it relates to the regulatory requirements that will be implemented under Basel III starting on January 1, 2013. I think it's important to take a step back and realize that effective January 1, '13, the minimum Tier 1 common standard under Basel III will be 3.5%. For those like us that will have a SIFI buffer of 250 basis points, that 3.5% will grow to 9.5% effective January 1, 2019.

As we've said before, we've made 3 points on this. The first, we expect our ratios to be well in excess of all of required minimums under Basel III. When we first report our Basel III numbers on a reported basis at the end of 2012, we would expect to be well above 8% on an as-reported basis. And third, as we've said before, if we were to look at and implement all of Basel at the end of 2012 on a fully phased-in basis, we would be somewhere between 6.75% and 7%. All of this is consistent with the previous guidance that we've given.

As we look at capital and growing capital beyond the end of 2012, we have a number of levers that we will look to continue to utilize, and I'd like to touch on a couple of those as we move forward. First, as we've said before, at the end of 2012, we'll have roughly $70 billion of risk-weighted assets under Basel III in a loan runoff portfolio that we would expect to run off largely by the end of 2015. We also have the credit correlation trading portfolio that we'd expect to be about $30 billion of Basel III risk-weighted assets at the end of 2012 that will run off largely by 2018.

From a private equity perspective, our private equity investments, we believe, will be approximately $50 billion of risk-weighted assets under Basel at the end of 2012, and we'll continue to work through those in '13 and beyond. Those 3 items obviously total about $150 billion of risk-weighted assets that we will look to work through in 2013 and beyond. Over and above that, we'll continue to sell assets that are not core to the customer franchise that Brian alluded on earlier. We will continue to be very focused on reducing MSRs, as I indicated before. Those are 100% risk-weighted deductions. And obviously, going forward, as we make money and use the deferred tax assets that we have on the balance sheet, capital will accrete at a rate greater than the amount of net income that goes through the income statement.

Brian Moynihan

Thanks, Bruce. So let me sum up a bit where we started. We have a great franchise here, and that franchise made up a great customer base, a great set of businesses and a great set of teammates who go out and make them perform everyday. We continue the transformation of this company that has been going on for 18 months plus. That leaves us very bullish on our prospects, and it's the amount that we can see [ph] For you, as our shareholders.

With that, Bruce, we'd be happy to start taking questions.

Bruce Berkowitz

Well, great. Thanks, gentlemen, for the update. We have about an hour left. You gave us a full review. We've received hundreds of e-mails of questions. We have over 6,000 listeners on the call right now. I know you've been out there in the public a lot, TV, various forms of communication. But given the amount of public information in the last couple of days and your opening remarks, well, I'll try not to repeat to supplement the questions that are already answered. Basically, investors are focused on the accuracy of estimates, the need to raise capital, future profitability, capital allocation and strategy. So let's begin with the questions on estimates.

Question-and-Answer Session

Bruce Berkowitz

First question is how you can you trust the current reserves given the adverse development?

Brian Moynihan

Well, I think, Bruce, I'd assume that that's both geared towards the general balance sheet plus in the mortgage areas. So I'll hit a couple of points, and I'll ask Bruce Thompson to hit a couple. If you think about -- the core areas we get the most questions about is in the mortgage-related balance sheet area. So on our balance sheet, we have home equity loans, what we call home equity loans and first mortgages. Home equity loans, actually, as Bruce mentioned, has a substantial portion which are first mortgages. And the way that we set those reserves is we look at the charge-off rates. We look at the projected charge-offs. We predict that, obviously, every month and every quarter and forecast it. And we can then act on that forecast for many quarters in a row. Embedded in the more delinquent loans, this is one of the things that is hard to make sure people really understand is anybody that is not paying us, once they go to 180 days past due and the mortgage portfolio is marked to a liquidation value on a continuous basis. So there's no -- even though we haven't liquidated the assets because the foreclosure process has been slow, they are marked as if they're liquidated and they continue to work down. And in fact, that's why the first couple of quarters this year, we've had some adjustments in the charge-off line reflecting valuation changes both for our purchase credit impaired portfolio and our generally held portfolio. So I think that's on a held mortgage book. We adjust them. We look at them. We've been acting on our predictions. The peak of the Home Equity charge-offs, $1.9 billion in 2009 third quarter, I think it was. It's down about $1.1 billion in the quarter. That is completely unacceptable. That's about 4% charge-off rate. But what we've seen is our ability to have that delinquency and charge-off dollar amount continue to come down even as the economy has been softer. And frankly, even as housing prices fell from '09 to now, which they have, we have seen charge-offs continuing to come down. So we think we established that, tested it, reviewed it on the on-balance sheet stuff. The commercial portfolios, you could see the credit quality is cleaned up dramatically. A lot of it's behind us. When you go to the mortgage putback risk, I'll let Bruce touch on that again, just on a high level to make sure that people understood the points before.

Bruce Thompson

Sure. I think once again, if you think about the mortgage putback risk and what we've seen, we basically have 3 types of rep-and-warrants that comes to us from the putback. The first is from the GSEs. As we've discussed previously and as I alluded to here, there's a fairly long period of which we dealt with the GSEs and worked through these mortgage putbacks. In each quarter, as we look at reserves, we reflect our reserves to reflect the experience that we're having for those, and those are on the balance sheet today. Over and above that, we have mortgage putback from both monolines, as well as private label securities. And I think as we've talked about before, we now have one settlement that we got done on the monolines. We've got one settlement we got done on the private labels. And on our balance sheet, we reflect reserves to reflect generally that experience. And to the extent that there are still a certain number of classes out there where we don't have experience, we reflect that in a range of possible loss that we disclose each quarter.

Brian Moynihan

And Bruce, I'll just back up and make one general comment. As you think about the amount of scrutiny our industry has gone through over the last 4 years since the crisis started in earnest in '07, you should believe that not only do we look at all the reserves and adequacy that's tested by all the usual parties on a given day.

Bruce Berkowitz

Right. And in terms of other assets of the companies such as derivatives, private equity, can you talk a little bit how you get comfortable with the current values reported?

Brian Moynihan

So we take some of the trading assets, basically, we have Level 1, 2, 3 assets. You can see in our public disclosures we have very deep price verification to check those. We cover most of the assets. So the reality is we don't have the kind of assets in the industry that if we had those 7 that were tougher to value, there's some, but the amount is far different, far less. And we continue to have those grown on a continuous basis. So Tom Montag and the team in that area plus the risk management team go through them routinely and check. Bruce, do you want to add anything?

Bruce Thompson

No, I would just add -- and I think if you look at each quarter, to give you a sense, coming in to 2009, we had legacy assets which we were not able to move off the balance sheet at the beginning of 2009 of roughly $56 billion. We've worked very hard over the course of the last couple of years to reduce those. At the end of the second quarter, we noted that those are down to $18 billion. So they've come down significantly. Obviously, most of them have experienced significant marks. And as you look at in any one quarter when we go through that and we sell those, there tend to be as many pluses as there are minuses. I think the other thing I would say is that if you look within that bucket, a decent chunk of those is within option rate securities that does marks -- reflect the current market. There tend to be a fair bit of activity. And what we've seen when we've ultimately sold those or they've been redeemed is very consistent with the way that we carry them on the balance sheet. The other thing I would say -- Brian touched on the credit and what we see in the loan books. And obviously, across the board in the markets businesses, those are mark-to-market businesses. So we mark those assets every day at the end of every month. The price verification teams look at them. And obviously, at the end of each quarter, they walk our accountants through that. So it's a very rigorous process.

Bruce Berkowitz

Given the recent news on Freddie, Fannie, AIG, MBIA, Attorney General, U.S. downgrade, how do owners get comfortable with the idea that there's no big hole left in the balance sheet?

Brian Moynihan

I think we continue to identify the risk, and I think most of that would be around the mortgage putback risk and then separately the securities litigation around the mortgage area, which is the AIG case. So we think about both those on a mortgage putback risk, think about $2 trillion of securities originated in the time frames we talked about, think about the agencies having half and think about the other half being private label or the small part monoline. And if you think about what we've been doing across the last couple of -- 3 quarters is taking significant amounts of that and negotiating a definitive settlement, as we did with Freddie Mac in the legacy Countrywide or as we did in the private label, or accruing, consistent with what we're seeing across the whole portfolio. So I think if you think about the mortgage putback risk we basically have accrued for on a consistent basis that we settled across all those assets for a significant portion, you have definitive resolution. There will be a debate until we get the final verdict, a final decision by a judge in the Article 77 case. There will be -- and it goes through appeals, which we told people will take a year to 1.5 years about -- will that settlement hold up. But I think if you look at the counterparties that looked at it, the amount of negotiation that went on, we think it's fair for us. We think it's fair for them. And I think there's a lot of people that have that same opinion, but that doesn't mean other people won't try to intervene. And they have done that, and the time frame for that is now. It will close out here shortly. And then we'll let the courts decide. When you go to the other part of it, the litigation, around securities litigation, we have had securities litigation about residential mortgage-backed origination practices in Countrywide for several years. There's a bunch of cases out there that we've been fighting. AIG is a similar case, as were the cases by the Federal Home Bank (sic) [Federal Home Loan Bank] Boards and other people and those aligning themselves for the system. But you should assume that we continue to adjust our litigation accruals based on our view of those cases in any given month.

Bruce Berkowitz

And then the last question we have, frequently asked on estimates, is how can investors verify your numbers?

Brian Moynihan

Well, I think in terms of accruals and stuff, I think we have a strong management team. We have a strong process. We have outsiders look at them. I think investors have to look at them and look at the recent most test and make their own decisions. But we have to test it first to see if they're reasonable, and we get ourselves comfortable that for what we know and how we look at it, we're able to assess the risk. And I think if you look at something like our reserves, just think of what happened over the last couple of years. We built tremendous reserves and now we're releasing them, which effectively meant that we built them in excess of what you needed. And you also have to remember that in our industry, we're not alone, so we have the regulators and others who look over our shoulders. So we get asked the same questions investor ask us by all of the third constituencies there are, and we go through that balances every single quarter and every single day.

Bruce Berkowitz

Okay. We're going to move now to the issue of bad debt. Big questions around the 2009 present period of loans versus 2005 versus 2008 vintages. When will the current loans in 2009 to the present overcome those from the 2005 to 2008 period?

Brian Moynihan

I think if you think about it, think about the loan book, say, snapshot 1/1/09 and think about credit cards, the mortgage that we have on our books and then commercial credit, commercial real estate credit, what was in those books, and let's just think about credit card, at that time, we probably had $220 billion of credit cards. We now have about $130 billion, $140 billion of core credit cards. And so in that downdraft, what happened was not that an average credit card purse was paid off. It's that most of the reduction, frankly, was charge-offs. So the portfolio as of 2005 to 2008 is the parts that were not good are gone. The people -- the charge-offs occurred. We charged-off in one single quarter $13 billion of charge-offs in credit card in any single quarter. So if you had 10 borrowers back there, you don't have a weighted average to look at the 10. You have the 7 good ones and the 3 bad ones are gone. And since that day, you've added 3 -- 2 or 3 good ones that are underwritten under very different circumstances. And we track it from the data originated now, and they performed well within our card [ph] rates. So if you think about that and the card business or even the mortgage book, you're burning through, for lack of a better term, the toughest loans. And the good loans that somebody survived from 2005 -- or 2006, 2007 as a credit card customer, made it through unemployment that went from 5% to 10%, and it's hung at 9% and still paying you, and still employed. That's a very good credit. And so even when we look at something like our Home Equity book, the portfolio of loans originated prior to '09 carries about a 700-plus FICO today refreshed. And that is due more to the quality of borrowers that are left over, frankly, than the quality of borrowers -- against the quality of borrowers that were not. So it's not a weighted average mix. It's a shift. People who are good before are still good and adding a lot of good people. Does that answer that?

Bruce Berkowitz

Yes. So if I'm hearing correctly, we're beyond the tipping point.

Brian Moynihan

Yes, there's a lot restored. People are...

Bruce Thompson

I think it's fair to say that we're beyond the tipping point. The other 2 things that I would add, Bruce, is that we've been after and have started tracking the different portfolios by vintage now, looking all the way back to 2008 and comparing how -- what we've underwritten starting in 2009 performed. And let me just give you a few data points. If you look at our U.S. Credit Card business and looked at the performance of some of the pools that we underwrote in the first quarter of 2008, 12 months out, delinquencies were 7.6% on that pool. If you look at what we underwrote during the first quarter of 2010, it went 12 months out, that delinquency rate is 1.49%. So when Brian alluded to the different standards that we changed in the fourth quarter of '08 and the first quarter of '09, think about that card performance. And if you think about and looked at both residential mortgage and home equity, you would see the same types of improvement that I referenced in the card portfolios.

Brian Moynihan

So one of the ways we see that evidence, Bruce, and we've been testing this and again, it's still early trend. If you look at the delinquency performance or charge-off performance of the consumer businesses from '07 through today, the correlation, the R-squared correlation up until the peak in the charge-offs in '09 was almost perfect. Unemployment rose. New claims for unemployment rose and charge-offs rose, and delinquencies rose right with them. What has happened is the delinquencies and charge-offs in these books continued to come down even though you've had a flattening in unemployment, sticking around 9.1, 9.2 and even though new claims, as you know, started going back up above 400,000 in March and April this year, it stayed there. So you've seen a break from the correlation, which was perfect up to the peak, and now you've seen a change pretty dramatically. So that is evidence that what happened as you are underwriting a higher quality customer and have frankly charged-off the customers who are not as high quality.

Bruce Berkowitz

Okay. When reading through -- Brian, when reading through the Q that fell off tremendous amount under the "bad debt label," can you talk a little bit about the characteristics on that bad debt in terms of whether it's legacy assets, what have you observed on the run-off rates, how long do they take to have the assets, the kinds of interest you're earning on those so-called bad assets and an idea about reserves and collateral value that cover?

Brian Moynihan

Sure, Bruce. Let's think about this in 3 broad buckets of bad assets. Let's think about the legacy assets business, which is a mortgage servicing business, which most of its bad assets actually aren't on our books, but we're servicing on that and that's more expense issue. And then we have some assets. We'll talk about that. Then let's think about the nonperforming assets in the company and the criticized assets and what's going on there. And then I think the third element that we have is the -- some special portfolios that are in the legacy asset servicing that are purchase-credit impaired that we talked about. And there's different outcomes for each of those. So on the mortgage servicing side, we split the company, the mortgage company, into 2 pieces. Looking at all the discontinued products we didn't want to carry forward, we had about 15 million loans we service, that was about half.

And so we are taking those and running down. We really don't have credit risk. The putback issue is a risk there in that discussion. We do not have credit risk on those portfolios technically. And the good news, as I said before, is of the 7 million, about 1.5 million, 1.6 million were delinquent. As of the beginning of the year, we're down to about 1.4 million, 150,000 reduction around numbers, 60 or more day delinquent loans because we're working through the system. So the key there is actually -- for the shareholder is to get those down because the operating costs of that group are about $1.5 billion, $1.75 billion a quarter that will get cost saves as we get those to more normalized environments. So that's what we're doing. One of the ways of getting down is actually to sell the PMSR that we sold, which was $500 million of capital release, but also lowers our risk by selling to 300,000-plus loans to other people to do the work so we can actually start to bring the expenses down. When we move the second book in the nonperformers and sort of core nonperformers commercial credit, I'll have Bruce talk about that, and how the reserves and how they -- sort of how that plays out in our mind, it is down dramatically, as you know, last several quarters. And then third book would be some specialized portfolios, which I'll let Bruce touch on, what we call our purchase credit impaired portfolios that are in our mortgage business.

Bruce Thompson

Great. I think, Bruce, as you think about on the credit side, it speaks to a couple of things. On the commercial side, the only real area that we have within commercial where we've got a significant number of nonperformers are within commercial real estate. I think it's important to note that portfolio has come down dramatically from roughly $80 billion down to $40 billion. If you look at that business, the credit quality and the number of refinancings that we're seeing we continue to work through. And if you look at the net charge-offs that we've seen in that business over the last 2 quarters, we've been running below $200 million a quarter within that business. The other thing and the last comment I'd make on commercial real estate that I think is important is that as we look at that and as we value it, once it goes nonperforming and we go to work that through, we take those valuations down to what we think the underlying collateral is worth. So as we look at it in the commercial space, the commercial real estate area, it was clearly the one that was most challenged. We've taken a lot of risk out of that. The charge-offs are down, and we feel very comfortable with where we've marked that on the balance sheet. The other 2 things that I would say as you think about credit, the first is the purchased credit-impaired portfolio that we brought on from Countrywide. In just broad numbers, the original principle of that was roughly $40 billion. That was roughly an $8 billion mark at the time the deal closed. The purchased credit-impaired portfolio as far as where it's marked now is down to about $25 billion. About 40% of that is delinquent. So we'll obviously have to work through that, and we'd expect to do so over the next couple of years. Once again, and I think it's important to know, as you think about valuations on the balance sheet, that portfolio gets marked every quarter as we look at the underlying values and take it through the income statement.

Brian Moynihan

I think to put it broadly though, if you think about the last several quarters, from second quarter of last year to second quarter this year, our charge-offs in the second quarter last year were $9.5 billion and we're down to about $5.6 billion this year. If you think about debt from a broad context, what was driving charge-offs in the second quarter of 2010 and the second quarter of 2009 was overwhelmingly the unsecured consumer business and cards, and that's down below $2 billion a quarter or down $2.5 billion a quarter. That's come down dramatically, as I said, from the peak of $13 billion. So those are loans that you basically charge off and don't have any recoveries. So the good news is the stuff that's a little more stubborn now in the Home Equity, which has a lot of first content, and the residential mortgage books are higher and will take longer just to liquidate those properties in a running 4% on home equities and 1.5% or 1.6% on residential mortgage. Way too high, but they will keep coming down. It's just a slower liquidation process. But if you look at that, those are secured portfolios and have more recoveries attached to them. So the real risk in our balance sheet back 4 or 5 quarters ago to 8 quarters ago was the small business, credit cards and the general credit cards, which are charging off and there's no recoveries. And now you're seeing a shift to more assets, which have good values, reasonable values underneath.

Bruce Berkowitz

That's outstanding. We're now going to move to questions on pretax, pre-provision earnings power. And the question basically is where are you now and how do you get to $45 billion to $50 billion of pretax pre-provision income over time?

Brian Moynihan

Sure. I think what we reported for the second quarter was around $8.5 billion to $8.7 billion, I think. $8.5 billion to $9 billion. I think it was $8.9 billion. Each quarter has been running around that. In the near term, as the margin settles in and depending on how the trading goes in a given quarter, that number could go up or down. So the question that people ask us often is, well how do you get from there to the levels that you talked about early this year? The first thing, order of business in that is that we were clear and we'll continue to be clear that because of the $45 billion level, you need to have an economy which is functioning more normally than the economy is now. So not a robust, crazy economy. An economy that goes 3%, 3.5%, we need that kind of economy for us just to churn out some of the profits. Because frankly, that will also resolve itself in a higher front-end industry of maybe 1%-plus as opposed to where it is now. And so that's one step. The rising rates to a modest level is worth $0.5 billion, $0.75 billion a quarter to us in pure profit. And one of the issues that we have in the industry is that as that potential pushes out, we've got to go work on the cost side. So if you think about some ways to think about where we are, you've got about 35 million to 36 million based on what I just told you. You've got to be careful that in that, there have been a takeout of a couple of million. But then you fill back really 2 basic pieces: interest rates in the environment where you have a reasonably growing economy and a front-end rate of 1.5% or something like that. That will cut fund rates, not at high rate but at reasonable rate, a more normal rate -- actually, a little normal rate. You'll go through about a $3 billion pickup on that. And then secondly, just from costs across the board, we know we can get out another $1.5 billion a quarter through LAS and the other costs. We'll get that, plus more probably. And so that will build the bridge back so that we'll get in the low end of 40s in PPNR.

Bruce Berkowitz

Key question now. Is this earnings power present -- going to the future, is expected earnings power enough to resolve all issues without raising capital within a wide margin of safety?

Brian Moynihan

Well, I think let's come at it the other -- come at it the way we've been working on it, which is we continue to drive the franchise and earnings power and we continue to take all the capital we can away from things which aren't core and put it against the ability to resolve issues and build the capital ratios we need under Basel III. So based on our view of the future, the risk itself of what we approve, we feel very comfortable. If you gave me a 4-year recessionary environment, something far different than what people predict, then I think that would be different. But that's not the environment that any of us is planning into and any of us expect. So given a normal, reasonable environment, a driving slow recovery and the continued work we're doing on the franchise and the ability that we have to move capital from things in our core into core, we feel comfortable that we can drive this business forward and make the capital ratios that Bruce talked, spoke about earlier.

Bruce Berkowitz

In regards to profitability, looking at the balance sheet, taking another view, is it possible for the bank over an entire business cycle to average a 1% return on assets and a 10% return on equity?

Brian Moynihan

So I think, Bruce, the way we've had this concern by investors, and it's a rightful concern, as we go all the way out to where the Basel III gets you with the full SIFI buffer and all the different things, the 9.5%, can you earn enough return on equity to make this business make sense. And I think a lot of us have -- by sheer mass, we had thought that we'd be sort of in the 8% capital level because of where we thought the SIFI buffer and other things would come out on the Tier 1 Basel III is now going to be 9.5. So we lost some of the returns. So we've said low-teens there. We're probably closer to what you just spoke about in terms of targets. The 1% ROA is a reasonable target for this balance sheet. It will take, as I said before, a little more than just margin health based on a reasonable yield curve with a front-end ratio, front-end Federal Reserve, Fed-funds type of number, 1.25, 1.5, to get there as we spoke about. But I think we're comfortable we'll get there given the normal business cycle. And I think that we will be fine-tuning the balance sheet, actually, to achieve that as we continue to look at it. Because if we don't achieve those returns, in other words, select businesses and fine-tune the balance sheet to get there, we're not going to get investors to invest in this industry. And so our job is to continue to optimize the franchise, and that's why the business mix we have helps on that: having the Credit Card business, which has higher returns on assets, having the -- with the Commercial Banking business, which has lower returns on assets but is much more efficient from a profitability, having the trading business which has volatility but can return clearly even on its balance sheet size, 1% ROA in most quarters, coupled with the Deposits business, which provides great stable funding for us at very cheap cost. And that's how we think about mixing the businesses. So we think those goals are achievable. We think that with the new capital levels, the ROE got depressed from what people thought it was going to be. But it's in the range there on the ROA. In order to get that ROE, we've got to get to that kind of ROA and we would have to optimize around it, to do it.

Bruce Berkowitz

In terms of cash, when will you be able to show owners the money via dividend and buyback?

Brian Moynihan

Bruce, this is one that I had no success on so far in the sense that trying to predict exactly. We need to get the work done that we have to get done and make sure we have the capital to run this franchise and continue to optimize the balance sheet. Our clear view that we've been saying to people is the expectation for capital return prior to us getting through the Basel quotation has to be very, very modest. And the rest of it -- and the -- but all the capital we store will go in our tangible book value per share calculation. That's why we're focused on it. So as we store up the capital we need to make the Basel III, that capital won't go anywhere. It sits on the balance sheet, gets capitalized in the company. It's not even put the risk, quite frankly, because it has the -- not the capital risk, so we have to raise more capital. So we will ask for a dividend when we're darn well sure that we will get the approval. And we're not going to ask for it a minute before. But I think just to keep people -- and as soon as we get that, our longer-term view is similar to what you've heard from my peers and even from the banking regulators, is once we get to the point where we're returning capital, the formula would be to return, say, 30% in recurring dividends and then of the earnings and then everything above that to use either to return through a special dividend or return through capital management. The time frame of that depends on us making sure that we've got the capital to run the company and to make Basel III and, as we said, anything between now and at the end of '12 is very modest.

Bruce Berkowitz

Right. You made reference to tangible book value in your answer, and it sounds to me that you look at the change in tangible book value as the change in intrinsic value of the operation or a change in the shareholders' wealth of the operation. Can you discuss that concept, how you look at it? And maybe comment on why -- what it means to you to have such a significant discount and the market price through tangible book value.

Brian Moynihan

Well, I'll take the last part first, and then we'll talk about how we think about it. The discount tangible book obviously represents people's views of whether -- what reserves or other things in advance is established. And we don't have that view, but that's what the market's telling us. And we have to keep showing the market how we built the fortress balance sheet reserves and capital and reflects opinions on a given day whether we'll have to raise capital. But that's what we see today, and we'll have to work through over time. But if you think about why we think of it as a metric for investing is that first, we looked at companies all across financial services and those that have done the best and have had consistent focused growth in tangible book value per share. And the reason why they've done the best is they've used capital wisely and continued to build the company and really not diluted the investor at the wrong time. So as we think about it, it's a watch point to say how do we make sure that every day your investments worth a little bit more in this company than it was the before the day before, and that's what we've been after. So since I became CEO, we've gone 12%, even taking some significant hits in our jobs to grow each quarter for you. When you think about it sort of longer term, the other thing we've got is when we end up with this buffer of capital, the SIFI buffer, capital like that, that will be capital -- that will be sitting on the balance sheet. If we put it to work to take risk, we're going to need more capital. So if you think about the 2.5%, you can't take risks with it. So therefore, the only way you'll see that and value for use in tangible book value per share is the shareholder. And in our case, that would be under Basel III, $18 billion per percent. So you can do the simple math. It's $645 billion. It would be $4.50 in tangible book per share as we build that up. But if we put it to work, we have to have more of it. So we have to also focus people on that part of inherent value we're building for you as the whole scheme works right and at the capital level. So tangible book value ratios that would imply that kind of capital of 7.5% or whatever it would be, you would come quickly to the conclusion that the people who have those ratios will survive any crisis that we've seen so far, including the last crisis, without raising capital.

Bruce Berkowitz

Great. A question has come up a bunch of times about insider buying. Why aren't more insiders buying if the stock is so cheap?

Brian Moynihan

Well, I'll say a couple things. One is everybody is should rest assured that my entire net worth is in this company of any consequence. I got paid last year in stock, which I don't get unless we perform a lot better than we performed in the recent quarter. And my management team is paid in the same way. So we're all paid in stock. We all have significant investments in stock. You have to remember, we just recently filed a 10-Q. It's got a lot of volatility around. So we believe in the stock, and you'll see us buy the stock when we're free and clear to do it. But with all the volatility going around, it's just that you've got to make sure that we've got everything done before we're legally allowed to do it. But the key thing there is everybody has really their entire net worth -- our associates are paid in stock. Anybody who gets paid a significant amount of money is paid more than half in the stock of the company [indiscernible] Over time.

Bruce Berkowitz

Brian, we have less than 30 minutes. Let's move on to strategy. The big question that comes up time and time again, is Countrywide ring-fenced? And if it is, why not consider a Chapter 11 restructuring for Countrywide? Is that a viable solution?

Brian Moynihan

When you're face with liabilities like this, we thought of every possible thing we could, but I don't think I'd comment on any outcome. And I wouldn't -- any judgment -- the path we've taken is the best judgment for the shareholders in this company.

Bruce Berkowitz

Okay. Fair enough. All this time, we're starting to get questions on offense. When will you go on offense against the critics? When is enough, enough?

Brian Moynihan

I'd say enough is enough already. But the fact of the matter is we go on offense everyday in the market. So if you look at what our teammates do in terms of winning business and delivering for our customers, that's the offense I care about. It's doing a great job for these customers, getting more business from them, making the money. And so we are on offense everyday. Our teams are out there winning deals. Our teams are out there servicing core consumers well. And we continue to invest in the places where we can get growth with an offense in wealth management business, adding more financial advisors, offense in the international business. Clearly, there's been a lot of talk about our company. In the last few days, if you just start back and think of the facts, $230 billion of total capital and equity assets ratio of 9.8%, tangible equity assets ratio of 5.87%, you just think about the sheer amount of capital, the sheer amount of liquidity we have over $400 billion, this is a great company. It's a great franchise. And we continue to go on offense every day in terms of winning the market, which is what I care about, which is delivering the shareholder value, delivering to our shareholders, doing great job for our customers.

Bruce Berkowitz

Performance, you've had a lot of harsh critics, everyone has their own personal opinion as to your performance. How do you grade your performance?

Brian Moynihan

I think my performance with the management team in terms of transforming the company, I think, has been strong. Our performance on the share performance has not been strong. I don't think that we see that in the market every day. But I think the way you have to think about it is, we've been in this business for 230 years, and we continue -- we'll be in this business for another 230 years. It won't be me, obviously, and it won't be you here. But there'll be somebody like us a couple of centuries from now talking about this great company. So this is -- I'd say that the way to think about this is we're in a multiyear transformation in a very difficult environment where we have to really reposition the company dramatically. So I think the greatest is still out there to be had. But importantly, we are very mindful of the share performance. And we can then do everything we can to drive it, but we've got to control the controls.

Bruce Berkowitz

Great. Thank you. All right. We have just a few set of subquestions before we go on to open the call up for Q&A. What topics? Counters to the forward reduction in fees.

Brian Moynihan

I'm sorry. I missed that part.

Bruce Berkowitz

I'm sorry. Your ability to make up for reductions in fees to the consumer and how you're going to [ph] account to that.

Brian Moynihan

Think about 2 major pieces of change. The first piece was the overdraft regulation called Reg E. And we made changes in anticipation of those rules in 2009. And so we are now -- that's all through the system. In the last couple of quarters, you've seen the entire impact of that. And so those fees are starting to grow, how we're going to make up for the overdraft fees, and the trade we made was -- you had a small portion of our customers paying a lot of overdraft fees because of the stress in the economy, what was going on, and we just didn't think that was right. So we fixed that along with regulation and fixed that, and the additional work we did on debit overdrafts is different than regulation but allows us to really drive what our customers to come. So what you should see is the way we're going to fix that is how we reprice the accounts, and how we're repricing accounts is shifting from the overdraft fees and mechanism to collect revenue to monthly fees, which when we talk to our customers and talk to advocates for those customers is a much clearer way for them to understand how they're paying as opposed to the application of overdrafts through the debit card transactions and things like that. So we're just at the low point of that. The Retail business made $500 million this quarter. Reflecting all that, it will start to creep back up and will make it back through 3 ways. Monthly fees that were -- as we restructure the accounts, which we've rolled out in several markets and will continue to roll across the franchise in the next 18 months. As rates rise, we will have the values change the customer and we'll have more of the rate structure to the industry and to us which is critical to the industry to maintain the balance and get back some of the rate structure losses, rates of tranche towards 0. And the third way is the operating cost. Because at the end of the day, if customers use our resources, which are substantial 5,800 branches, 18,000 ATMs, with our 30 million online customers, our mobile banking facilities, our phone capabilities, if customers use all of that, what that allows us to do is serve a lot more cheaply. And as we've seen customers do that, the reason why we're closing branches is because customers don't use them for the same purpose they used to, and we're allowed to take that cost. So it's rate, fees and ultimately cost, and we're kind of comfortable. The real way we got paid back when making a change, though, was the lower attrition. We are down to attrition rates that didn't exist in this company. It was a lot smaller. And the customer satisfaction with us in our consumer deposits businesses is much stronger, and that's led to net new growth for checking accounts with a lot less sales and churning and burning. So that's how we make it up on the overdraft fee side. On the Durbin amendment, as we've been clear, that's about $2 billion a year deduct from us because we're the largest in debit card uses by far in the industry and it costs us more than other people. Again, in the repricing of the accounts, we have accounts repricing that will help us make that up over time. That will take us '11, '12 to restructure all the accounts because literally, we have to convert every single checking account in the franchise to a new account.

Bruce Berkowitz

Great. Another question came in. Why not allow consumers to opt in on late fees?

Brian Moynihan

On overdraft fees?

Bruce Berkowitz

Yes, overdraft fees.

Brian Moynihan

We do. We allow them.

Bruce Berkowitz

Right. Mortgage forgiveness, how is it going to help Bank of America?

Brian Moynihan

I think we think in very targeted circumstances where the net present value investor is strong and that we don't create the issues of strategic default and stuff. I think if it's in the best interest of investors to service the loans, we can administer that. And I think anything to stabilize the housing market in the broad context is good for the economy and good for housing. It keeps pushing forward. I'd step back and think, what we're seeing in housing is actually kind of interesting now. In the markets where we can get hold of the properties and from series of the length so far, it's 2 years or more to get through the foreclosure process. You're seeing a very robust market and a sale in, say, 69 days in most cases to get the property. There's tremendous investor interest. The sales price in some of these markets on sort of investor purchase, sort of more distressed purchase for this versus a sort of retail purchase between you and the interested people are tightening up dramatically in terms of sale prices. There's strong investor demand to buy homes and rent them. And you've seen some recent announcements about trying to expand those programs, which I think would be tremendous because building more multifamily homes where there's different people living in or coming out of single-family homes is not great use of our resource in this country. So I think if you look around, I think the third factor in the states where the foreclosure takes place, you're seeing the system unclog and move through. That's different than states that are still going through the foreclosures, going through very slowly. And then interestingly enough, you'll start to see price stability achieved in the states where you can get through this. So our job is to get it through. Anything we can do that makes sense in serving our investors well to help makes sense to us.

Bruce Berkowitz

Right. And then last question on trend. Trends in the labor and assessment charges, cost of foreclosure delays, new servicing guidelines.

Brian Moynihan

We are taking charge the last couple of quarters with these things. I'll let Bruce cover the foreclosure delays. Bruce.

Bruce Thompson

Sure. A couple of things I'd say. On the assessments and fees, obviously, we've had those over the last 2 quarters. As we go through and estimate those, we take those foreclosures that have gone through the guidelines and project forward what we'll owe, and we've accrued that. I think the important thing, and I'll go back to the comment that Brian made, and what we're very focused on is working through where we're the servicer to get the homes through the foreclosure process on a more expedited basis. And during the second quarter earnings call, we talked about how we've seen roughly a 10% decline in a number of significantly delinquent homes. We're very focused on either the deed-in-lieu or the short sale process, and I think since we've moved and basically put 2 different activities in the mortgage company between the legacy assets and the front end, we feel that we've made good progress in working through those on a more expedited basis.

Brian Moynihan

Bruce, just on the housing generally, this is the sort of last remaining issue to kind of work through from the last crisis getting through this inventory. But when we say 1.6 million moving down by 150,000, that includes all new entrants to that, all new 60-day-or-more past due. So if you really think about what's going on, we have 15 million mortgage customers, round numbers, in that 1 in 5 out there. If you start to look at it, what's really happening, the good news is delinquency in the portfolio, the early-stage delinquencies, keep moving down slowly but surely every single month and quarter in terms of dollar amounts. So customers -- because even though employment's not gotten a lot better, it hasn't gotten a lot worse. So the customers continue to make it through. With that also, we're able to continue to modify mortgage loans. We've modified, I think, 60,000 round numbers in the second quarter. We'll continue to modify loans we can. Those the ones that we can't, we need to take through the process, as Bruce said. But the reality, I think, is that where the process can take place, the good news is you get to the other side. And I think that the challenge is how we continue to have homeowners and handle homeowners well so they can keep living and keep doing what they need to do. And the economics of homeownership is difficult for those homeowners. We need to separate to make sure they have good places to live so we can keep them at work and keep their kids at school and things like that.

Bruce Berkowitz

Great. That ends our e-mail Q&As, and now I'd like to ask Michelle to open the lines for questions and remind everyone how they can ask a question. Are you there, Michelle?

Operator

[Operator Instructions] Our first question comes from Jim Mahoney from Oxford Financial.

James Mahoney - The Daily Oil Bulletin

Question is, Brian, can you comment a little bit just on the degree and composition of your European exposure and just with all the concerns that are continuing to escalate? And it seems like things are still somewhat deteriorating with regard to the European sovereigns and the banking system there as well. How do you see that impacting you guys? And is this because something on the margin causes you to have to raise new capital going forward?

Brian Moynihan

Sure. I'll start. I think I'll let Bruce talk about some of the numbers. Bruce has got some of the numbers. But I'll start by where we finished it. What Bruce said in the second quarter, it's still absolutely true. There's nothing here that's a capital question. But let's go back and think about what we did in the last 18 months. Last year, if you remember, the capital markets froze up in May, April, May 2010 when the European sovereign debt crisis or the banking crisis there sort of kicked its first time and their sovereign crisis kicked up the first time. And markets froze and things really shut down. And we then really looked at it and said, you know what, there's not a lot of ways to figure out which way this is going. So we had to bring down our risk and continue to bring down our risk all through that period. As these things moved from country to country, we continue to manage ahead of that, making sure that our risk is down overall and the team and the trading team in our Global Markets area has done a very strong job of doing that. And so that's sort of the general answer as we started last year. This is not a surprise to us as this thing will be -- take time to get -- where it's a very difficult situation with many different -- at least in the United States, you have difference of opinion, but you have one system of government that you're working through there. You have multiple difference of opinions and multiple systems, and it's very difficult. But the recent initiatives are great moves by those policymakers to continue to try to show that they'll support the economies and make sure that the situation gets under control. Our technical risk, I'll let Bruce talk a little bit now.

Bruce Thompson

Sure. I think if you take a step back and think about the way that we look at the exposure, we're obviously very focused throughout the world on looking at exposure. The area that's drawn the most attention are obviously the countries of Greece, Ireland, Italy, Portugal and Spain. And going back to the first quarter of 2010, as we started thinking about sovereign debt and sovereign exposure, as Brian alluded to, we took the hard look at the types of risks that we were taking and focused very much to make sure that we were comfortable to the extent that there was a prolonged period where this went on. And if you look at our 10-Q, I think that the most telling thing that we can speak to is within that region, we had $16.7 billion of exposure. Of that exposure, roughly $1.6 billion of it was to sovereign entities, and we had credit default protection on roughly $1.5 billion of that $1.6 billion of exposure. The other 2 comments I would make with respect to the balance sheet, as you think about that, is all of the non-loan books in those countries are mark-to-market every night, including the default protection that we have. And secondly, and consistent with this strategy, if you think about the lending we do in those countries, it tends to be too large public multinational companies in order to make sure that we don't have any tall trees or outsized exposure there. Sometimes we do once we get above certain levels by credit protection, and that's not been reflected in the numbers that I've given to you as I walk through this.

Brian Moynihan

I think the other thing is that just remember that Europe in a consolidated basis is another huge part of the world's economy. And to the extent that it takes time to grind through this, it slows down the overall growth rate in the world. And I think all of us in the world are affected by the general economic growth rates. Banks, services companies, as well as other companies. So I think that the impact on the markets this time, up until the last few weeks, has been relatively muted. The U.S. capital markets and other worldwide capital markets, whether it's Asia, Latin America, just kept plowing [ph] Through. I think that this situation, combined with the situation in the United States, slowed things down. And hopefully, as people settle in and understand what the different pieces are, we will get back to normalcy. But I think it's really general economic issue as opposed to specific risk issue.

Operator

Your next question comes from Jim Sinegal from Morningstar Equity.

James Sinegal - Morningstar Inc.

I was wondering if you could provide any additional color around the major assumptions you're using in estimating the reps-and-warranty liability, especially any variable that can lead to that number being higher than you currently expect.

Brian Moynihan

Sure, I'll let Bruce talk.

Bruce Thompson

Yes. I think that the -- as you should think of the rep-and-warrant, a couple of things. The first is, as we look out at, and we talked about it in our second quarter earnings call, a significant component of rep-and-warrant is what happens to home prices. So because home prices obviously reflect or impact the collateral losses that investors incur, and that's the basis upon which people look for rep and warrant. As we've said before, we look at and use median estimates for home prices. And in our numbers for both rep-and-warrant, as we think about those, as well as our general credit reserves, we've assumed that 3% decline in home prices over the course of 2011. And in 2012, we assumed they're up very modestly in the first half of the year. And in the aggregate for the year, 1% for 2012. So that's how we think about the home price component to it. And if you put back to the way that we think in rep-and-warrant, I'll go back to the original comments that we made, which is we obviously -- we have a normal course of dealing with the GSEs. We have -- we've reflected our reserves in the second quarter to reflect that behavior and basically with the GSEs plugged in the home price assumptions that I just gave you to look at those. And the assumptions that we have with respect to the non-GSEs, I'll just go back and I think the overriding assumption is we look at the other rep-and-warrant assumptions. We've had one large settlement with a very well-capitalized monoline FSA assured, and we've had a large settlement that we're working through the process with Gibbs & Bruns where we've got 22 of the largest investors in the world, along with the trustees' experts that they've hired to say that, that's fair. So I think just from a macro perspective, those are the 2 -- those are the 2 data points that we use because we think they're the best data points as we go to formulate the overall rep-and-warrant liability.

Brian Moynihan

So I think simply put, some of the margins that we use market-based use and then in our forecasting and bring it in, whether it's interest rate environments or things like that, and then look at it and adjust around that. And I think what we saw in the last couple of quarters was a continued movement to adjust across a large amount of risk spontaneously, which produced $0.25 million in the first quarter. But when you think of the context, the total liability booked so far it's relatively small adjustments. And so we'll continue to manage that, but you'll see everything we know. That's fine.

Operator

Your next question comes from Richard Jain (sic) [Rajat Jain] from Litman Gregory.

Rajat Jain - Litman/Gregory Research, Inc.

I have a question regarding the counterparty risk you take on with the European banks. Can you give us a dollar amount of the worst downside risk you might have associated with your dilutive positions? And also, can you also speak to how confident are you or can be in this assessment?

Brian Moynihan

Well, I think I'll let Bruce get through it. The process we use is an assessment based on the credit and based on the particular transactions that Bruce will take you through. But if you think about even through the '08 prices and beyond, and there's been many market movements that are fairly significant even over the last 1.5 years in this area, we've been able to manage through them well and make sure we don't have risk to any one party that stabilized across the company. And so, Bruce, why don't you talk to our specific risks?

Bruce Thompson

Sure. Where it stays -- if we take a step back and look at what we do internationally through our risk area and working with the lines of business we establish by country, the amount of risk that we're willing to take within each individual country and then within those countries, we allocate that risk across different areas and different products, what I would say is that we obviously monitor every night the amount of counterparty risk that we have when we go through periods of stress like this. We, obviously, from an operational perspective, go into a heightened step -- a heightened state of readiness. And I think as you think about the counterparty risk, and I'm not going to get into specific names. We're very cognizant of managing each individual name within the limits that we set for each of those counterparties. And I think the other thing that's much different, and that's why the operational aspect of this is even more important than it has been before, that the majority of the work that we do through our trading businesses with counterparties, there's the obligation to post collateral on virtually every day. So we've got limits. We know what the exposures are by each type of exposure by each counterparty. And in times of stress, we obviously are particularly focused on making sure that the collateral flows are what we would expect. And what I would say is that I think what we've clearly gone through 2 fairly stress periods between when the debt crisis in Europe started during the second quarter of last year, as well as what we've gone through at this point, and we just haven't had any problems at all.

Rajat Jain - Litman/Gregory Research, Inc.

So is it fair to ask, can you quantify the dollar amount based on your stress testing? And what's the worst dollar amount you can come up with? Is that a fair question to ask?

Bruce Thompson

We test that. I don't think -- we run within limits to test across our portfolios, what amount of risk we'll take under many, many different stress scenarios and then we manage that. We don't put that out there. I mean, you can see -- you can make judgments on our value of risk, which we do publish, but we have other stress scenarios that we look at to make sure that no matter how bad it gets, if the '08 circumstances come again and exist a long period of time, largely the fixed income books will be the ones you have to watch that you know that you'll lose enough money to prepare this company for the threat [ph] .

Bruce Berkowitz

I'm afraid we only have a couple of minutes left to go, and I would like to be the one to ask the last question. Given all the confusion, the wide range of speculative numbers that people are talking about with the reps-and-warranty and litigation, the legal cost and everything, do you have a message for all the listening litigants out there on how all can settle up and move on for the sake of everyone's business and for our country?

Brian Moynihan

Well, I think, Bruce, we've been clear that where people have a reasonable view of what they think the liability is that is close to our reasonable view, then we get things done. That's what we did with Freddie Mac. That's what we did with Fannie Mae on a big part of our portfolio last fall. That was in the fourth quarter. That's what we did with Assured Guaranty. That's what we did with the group of investors in Bank of New York and the private label Countrywide. And I think the message is that we have made revisions that ought to cover us in what we think are the recent circumstances. Some people believe that there's more there, and I think we saw some of that this week, and we'll see them in court, if that's what it takes.

Bruce Berkowitz

Okay. Brian Moynihan, Bruce Thompson, thank you very much for spending 1.5 hours with us. I'd like to thank all the participants for the call today. There will be a replay of the call, and a transcript will be made available on our website, www.fairholmefunds.com. Thanks again, gentlemen.

Brian Moynihan

Thank you.

Operator

This concludes today's conference call. You may now disconnect.

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