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    Forces of Change:

    A Three-Part Series Making a Case
    for Change in Cross-Border Payments

     

    Part 3: Regulatory & Macroeconomic Risk

    How are banks managing through unprecedented regulatory and macroeconomic times?

     

    The banking world changed forever after the global financial crisis. Quantitative easing (QE) programs and new regulations reduced yields and raised compliance costs, while higher capital and liquidity requirements put immense pressure on bank returns.

     

    As a result, banks spent the past decade adjusting their business models to cope with these changes, and will continue to do so as challenges posed by new macroeconomic and regulatory environment changes. While there may be more clarity in the regulatory outlook, what happens as policymakers slowly raise rates from a zero base and as central banks start selling assets remains uncertain. 

     


     

    Mark Smith, Head of Global Liquidity for Bank of America Merrill Lynch, has thoughts on how banks are adapting to this unprecedented environment. 

    Download Transcript

    Q1: How have banks' business models been forced to change?

    Banks faced a triple threat in recent years in terms of reduced revenues, increased costs and lower returns.

     

    Net interest margins have been under pressure due to low interest rates and QE programs, which have compressed the spread between the rate paid on deposits and the interest yield on loans.

     

    Compounding the issue, companies have hoarded record amounts of cash on their balance sheets, reducing their need to borrow from banks. This has led to slower loan growth, tighter loan pricing and a record surplus of deposits over loans on bank balance sheets. These factors, coupled with a low, flat yield curve, have acted as a drag on bank yields and revenues.

     

     

     

     

    A flat yield curve has squeezed banks’ earnings

     

    Average Spread Between 3 Month and 10 Year US Treasuries, %

     

    Source: US Treasury (*To end-May 2017)

    Corporate cash reserves rose steadily after the financial crisis

     

    The leading 1,200 public non-financial companies had $3.5 trillion in cash reserves at end-2013, up from $2.1 trillion at the end of 2007

     

    Source: Deloitte, 2014

    US banks’ reserves have skyrocketed

     

    They rose more than 1000-fold from $1.8 billion in December 2007 to $1.9 trillion in December 2016

     

     

    Source: Federal Reserve Bank of St. Louis, 2016

    While yields have been declining, the cost of complying with new regulations has been rising. In 2016, some 69% of compliance professionals at financial services firms expected their compliance budgets to rise, squeezing profitability. (Source: Thomson Reuters, Cost of Compliance 2016)

     

    Completing the perfect storm, higher post-crisis capital requirements have meant the return on equity across the banking industry is significantly below pre-crisis levels.

    New regulations affecting capital and liquidity

     

    Rules requiring banks to hold high quality liquid assets on their balance sheets include:

     

    • Liquidity Coverage Ratio
    • Net Stable Funding Ratio
    • Recovery and Resolution Planning
    • Internal Liquidity Stress Testing
     

     

     

    Rules requiring banks to hold more capital on their balance sheets include:

     

    • Basel III advancement of risk-weighted assets
    • Supplementary Leverage Ratio
    • Global Systemically Important Banks (GSIB) buffer
    • US Comprehensive Capital Analysis and Review (CCAR or "stress testing")

    Q2: How have banks evolved?

    Those banks that reassessed how they do business in response to new rules are in a stronger position to take advantage of a brighter economic and regulatory outlook. For example, while US universal banks haven't fundamentally changed their models, they have adjusted them to the new environment. They've had to measure how their activities consume balance sheet and capital, how they attract risk and compliance costs, and then reduce exposure to products and markets which don’t generate adequate return on balance sheet/capital, or relative to risk.

     

    Large European banks have generally had to adjust more severely, with many cutting balance sheet size significantly and others exiting products and geographies in order to focus on core markets. In Asia and Latin America the financial crisis was less severe, while post-crisis regulation is more nascent. The challenge for banks in these regions, with no common regulatory bodies, is anticipating how regulations will unfold in each individual country, and how much regulatory compliance will cost.

     

    Crucial to all of this is understanding and measuring how a bank's activities attract capital and risk. How do banks develop metrics to optimize returns on that capital and on those risks? If you can’t measure it, you can't manage it.


    Q3: What has been the impact on correspondent banking?

    Rules associated with KYC and sanctions screening have materially increased the compliance costs associated with correspondent banking. On average financial institutions spend $60 million a year on KYC and Customer Due Diligence (CDD) procedures. Some banks are reported to spend in between $100 million and up to $500 million on KYC/CDD and client onboarding. (Source: Thomson Reuters Survey, 2016).

     

    But even if you set higher compliance costs to one side, the risks associated with correspondent banking related to money laundering and sanctions violations are much higher than for most banking activities. Against that, correspondent banking remains a high-volume, high-margin business typified by economies of scale and straight-through processing.

     

    Consequently, top tier correspondent banks will find it much easier to find partners and are likely to enjoy competitive pricing for their business. Smaller, less well known correspondents will find it harder to attract partners, are likely to experience higher pricing and be pushed out further in the network.


    Q4: Are US banks in a stronger position?

    The US has generally implemented prudential regulations more quickly than elsewhere, and while it has been a painful transition since 2008, large US banks are now arguably in a position of "regulatory strength" relative to the rest of the world.

     

    Stricter regulations have required US banks to build and maintain "fortress balance sheets", buttressed by increased levels of liquidity and capital. The challenge has been generating an adequate return on post-regulation capital and balance sheets. While they have adjusted their models to focus on their strengths, universal banks like Bank of America Merrill Lynch have still maintained a diversified product offering, enabling them to serve clients in multiple sectors and geographies. 

     

    Crucially, this broad wallet penetration across credit, capital raising, advisory, global markets and transaction banking can still earn a good return on capital and balance sheet. US universal banks with fortress balance sheets are therefore in a strong position to benefit from a more stable regulatory environment to help drive sustainable economic growth.


    Q5: What risks are banks facing?

    Risks to the economic outlook remain, including those from unpredictable geopolitical events. We’re also in uncharted monetary policy territory. While we’ve been through rate rising cycles before, we’ve never started this low, nor increased this slowly. There is no precedent for the unwinding of quantitative easing and how that will affect the yield curve. 

    That said, there is probably much more upside than downside for US banks, which have learned to survive in a low or flat rate environment. Fortress balance sheets, rising benchmark rates, and the prospect of a steeper yield curve offer US banks the opportunity to benefit from, and support, responsible economic growth.

     

    The same cannot yet be said of banks in other regions, where economic recovery and regulatory reform has been slower than in the US. In Europe, for example, a number of banks are still recovering from the crisis – rebuilding their capital and refocusing their business models. The risk for such banks is that they fall behind their US counterparts and lose market share. Another interesting risk relates to the repatriation of dollars to the US, a large quantity of which is held by foreign banks and used to fund their dollar assets. How easily will those non-US banks be able to find alternative USD funding?

    In unprecedented territory

     

    The US federal funds rate has never before risen from a zero base

     

    Source: Federal Reserve Bank of St. Louis, 2015


    Q6: How will the regulatory environment evolve over the next five years?

    The US is likely to see a more stable environment, where major regulatory changes are generally known and accommodated. The hope is that banking regulation will become more efficient by precisely targeting risks in the system, freeing up resources, liquidity and capital which banks can then use to help drive economic growth. 

     

    For example, US regulations require banks to manage deposit liquidity risk under at least five different scenarios for three major rules – Liquidity Coverage Ratio, Recovery and Resolution Planning and Internal Liquidity Stress Testing. These rules generally treat the same deposit differently. Simplifying these into one or two scenarios that banks and supervisors agree are most effective would make it easier for banks to allocate liquidity against liquidity risk, speed decision making, and free up resources to help drive growth.

     

    The picture elsewhere is less clear. Regional banks in Asia-Pacific and Latin America face the challenge of complying with evolving regulations in each of the jurisdictions in which they operate, inevitably pushing up compliance costs. And even where there are supra-national regulators, such as in the EU, the pace of adoption of prudential rules such as Basel III has been behind that of the US. This could make it harder for some European banks to compete with their US peers, whose business models and balance sheets have already adjusted to a more mature set of regulations, and who are now well positioned to support clients in an environment of economic growth.


    Q7: How should banks adjust to this new reality?

    Since 2008, banks have learned that the balance sheet, including capital, is a precious resource, and a binding constraint.  Accommodating anything for any client at any time and at any price is no longer an option. Banks need to measure, analyze and understand their binding constraint – their capital and balance sheet – and orient their activities to those clients and products which generate an adequate return. Exiting sub-hurdle products and relationships is painful, but the only way to position optimally for the opportunities presented by economic growth in the new regulatory world.

    At Bank of America Merrill Lynch, we view disruption as an opportunity, not a problem. So in a world where continual change is the norm, we tailor solutions, ranging from global cash management to structuring green bonds, that help future-proof our clients’ businesses and propel them forward.


    AUTHORED BY:

    Mark Smith

    Head of Global Liquidity

    Bank of America Merrill Lynch

    Key Takeaways

    • Macroeconomic and regulatory policy have permanently affected banks’ business models
    • With fortress balance sheets, large US banks are particularly well positioned to help drive sustainable economic growth
    • Banks globally must focus on their strengths and deploy their balance sheet accordingly

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    Certain hyperlinks on the Sites may link websites maintained by the Affiliates, which are not to be considered a part of the Sites. Certain other links on the Sites to non-affiliated third-party sites may contain information over which we have no control. We take no responsibility for the content, accuracy, content, completeness, timeliness, current value or any aspect of the information on these sites and disclaim any liability to Client for it or for any consequence of your decision to use the links provided or your use of such information. Links to non–Bank of America sites do not imply any endorsement of or responsibility for the opinions, ideas, products, information or services offered at such sites, or any representation regarding the content at such sites. We also disclaim all liability and make no representations or warranties for any products or services sold or provided to Bank of America or its Affiliates by any third party. Your purchase of products or services through one of those other sites is subject to agreements and/or the terms and conditions in effect between Client and the providers of products and services at those other sites. Client agrees that it shall not bring a suit or claim against Bank of America or its Affiliates arising from or based on your purchase or use of products or services through those other sites. Links do not imply that Bank of America, its Affiliates or the Sites sponsors, endorses, is affiliated or associated with, or is legally authorized to use any trademark, trade name, logo or copyright symbol displayed in or accessible through the links, or that any linked sites is authorized to use any trademark, trade name, logo or copyright symbol of Bank of America or its Affiliates.

    CONTENT AND SERVICE AVAILABILITY

    Bank of America or its Affiliates may make changes to the Sites and reserves the right to do so without prior notice to you. Client acknowledges that not all products and services listed or discussed in the Sites are available in all geographic areas. Your eligibility for particular products and services is subject to final determination and acceptance by Bank of America or its Affiliates.

    CONSENT TO ELECTRONIC DELIVERY

    You agree to receive certain documents and information provided by Bank of America and its Affiliates through the Sites and/or through email provided to you via the Sites. This delivery will generally consist of certain Content on the Sites, and certain other documents relating to Bank of America and its Affiliate’s business. This electronic provision and delivery will be regarded by you as appropriate delivery pursuant to any delivery requirements under the various statutes and rules, where applicable, of the Securities and Exchange Commission, the National Association of Securities Dealers and any state or other jurisdiction. You acknowledge that you have the appropriate technological equipment to use the Sites and to receive email via the Internet and understand that your use of the Internet may incur certain operational costs such as monthly fees for a service provider. You agree to notify Bank of America or the applicable Affiliate in the event that you no longer desire to receive content through this delivery procedure and will allow a reasonable amount of time to permit proper delivery to you through other means.

    NO WARRANTY

    Client acknowledges that any information provided through the Sites is not intended to be a recommendation, offer or solicitation of any particular products or services. In addition, all research, analysis and similar market information from non-affiliated third parties provided represent the views and opinions solely of the author or the indicated source. Bank of America and its Affiliates do not independently verify the accuracy or completeness of such information, nor does Bank of America and its Affiliates endorse any particular views expressed therein. Except for offering memoranda, Bank of America and its Affiliates disclaim any liability to Client for this information or for any consequence of your decision to use it. Client agrees that it shall independently confirm any such information presented through the Sites before relying on such information. Bank of America, its Affiliates and their respective employees, contractors, agents and various contributors to the Sites have no duty to correct or update any inaccurate or out-of-date information on the Sites.

    Client acknowledges that it is acting for its own account, and it has made its own independent decisions to enter into a Transaction and as to whether a Transaction is appropriate or proper for it based upon its own judgment and upon advice from such advisors as it has deemed necessary. Client is not relying on any communication (written or oral) of Bank of America or its Affiliates as investment advice or as a recommendation to enter into a Transaction; it being understood that information and explanations related to the terms and conditions of a Transaction shall not be considered investment advice or a recommendation to enter into that Transaction. Further, Client has not received from Bank of America or its Affiliates any assurance or guarantee as to the expected results of a Transaction.

    COMPLIANCE WITH LAWS AND INDEMNITY

    The Sites may be used only for lawful purposes. Client’s conduct may be subject to local, state, national and international laws. Client agrees that it and any of its Authorized Persons shall comply with this Agreement, applicable laws, rules, regulations, ordinances and other similar national and international requirements of the country, state and province in which you are accessing and using the Sites.

    Client agrees to abide by applicable export control laws and not to transfer, by electronic transmission or otherwise, any content on the Sites subject to restrictions under such laws to a national destination prohibited under such laws, without first obtaining, and then complying with, any requisites government authorization. Client further agrees not to upload to the Sites any data or software that cannot be exported without prior written government authorization, including, but not limited to, certain encryption software. This assurance and commitment shall survive termination of these Terms and Conditions. Offices, residents and operations of your organization in Cuba, Iran, Iraq, Libya, North Korea, Sudan, Syria and any other countries that are the subject of sanctions by the United States Office of Foreign Asset Control or other general U.S. embargo restrictions are not permitted to access and use the Sites, and any such access and use is a violation of these Terms and Conditions.

    Upon request by Bank of America or its Affiliates, you agree to defend, indemnify and hold harmless Bank of America, its Affiliates, their officers, directors, employees, agents, contractors or other suppliers from all liabilities, claims and expenses, including attorneys fees, that arise from a breach of these Terms and Conditions for which you are responsible, or from third-party claims arising from your use of the Sites. Bank of America and its Affiliates reserve the right to assume the exclusive defense and control of any matter otherwise subject to indemnification by you. Notwithstanding the foregoing, you are not required to indemnify Bank of America or its Affiliates for its own violations of applicable laws.

    • FOR RESIDENTS OF BRAZIL:

      The information contained here does not constitute a public offering or distribution of securities in Brazil and no registration or filing with respect to any securities or financial products available on the Sites has been made with Commisao de Valores Mobiliarios.

    • FOR RESIDENTS OF CANADA:

      The information contained here does not constitute a public offering or distribution of securities in Canada or any of its provinces. No registration or filing with respect to any securities or financial products available on the Sites has been made with any regulatory agency thereof.

    • FOR RESIDENTS OF FRANCE:

      The Sites do not constitute a solicitation to enter into a transaction involving financial instruments, is not being distributed in the context of a public offer in France within the meaning of Article L. 411–1 of the Monetary and Financial Code, and has thus not been submitted to the COB for prior approval and clearance procedure. Any offers, sales or distribution of financial instruments through the Sites shall only be made in France to qualified investors (investisseurs qualifi?s) as defined in and in accordance with Article L. 411-2 of the Monetary and Financial Code and d?cret no. 98–880 dated 1st October, 1998. The contents of the Sites may not be redistributed or reproduced (in whole or in part) by any User. The Sites are made available with the understanding that Users will make investment decisions for their own account with the conditions set out in d?cret no. 98–880 dated 1st October, 1998. By using the Sites, Users undertake not to transfer, directly or indirectly, any financial instrument acquired through the Sites to the public in France, other than in compliance with applicable laws and regulation. Services hereunder may be provided by Banc of America Securities, Limited, as agent or otherwise.

    • FOR RESIDENTS OF GERMANY:

      The Sites are made available only to professional investors as such term is defined in the Securities Sales Prospectus Act.

    • FOR RESIDENTS OF HONG KONG:

      Access to the Sites is by invitation only to institutional investors. No information or material contained in the Sites is or should be construed as amounting to an offer to enter into any transaction or investment whatsoever. The information on these Sites is provided by the Hong Kong branch of Bank of America, N.A., and is compiled from information prepared by subsidiaries and affiliates of Bank of America Corporation. Your agreement for the use of this Site is with the Hong Kong branch of Bank of America, N.A.

    • FOR RESIDENTS OF IRELAND:

      Access to the Sites is by invitation only to professional investors.

    • FOR RESIDENTS OF ITALY:

      Access to the Sites is by invitation only to professional investors as defined in article 31 of CONSOB regulation no. 11522 of July 1, 1998.

    • FOR RESIDENTS OF JAPAN:

      Access to the Sites is by invitation only to financial institutions as defined under the Law Concerning Foreign Securities Firms.

    • FOR RESIDENTS OF KOREA:

      Access to the Sites is by invitation only to professional investors with a valid password. The information contained here does not constitute a public offering or distribution of securities in Korea.

    • FOR RESIDENTS OF NETHERLANDS:

      Access to the Sites is by invitation only to professional market parties as defined in the Dutch Securities Transactions Supervision Act 1995. Securities or other instruments on these Sites are only offered to professional market parties.

    • FOR RESIDENTS OF SINGAPORE:

      Access to the Sites is by invitation only to institutional investors. The information contained here does not constitute a public offering or distribution of securities in Singapore. The information in these Sites is provided by Bank of America Singapore Limited and is compiled from information prepared by subsidiaries and affiliates of Bank of America Corporation. Your agreement for the use of these Sites is with Bank of America Singapore Limited.

    LIMITATION OF LIABILITY

    THE FOLLOWING LIMITATIONS OF LIABILITY IN THIS SECTION SHALL NOT APPLY TO VIOLATIONS OF LAWS RELATING TO THE OFFER AND SALE OF SECURITIES. YOU ACKNOWLEDGE THAT NEITHER Bank of America, ITS AFFILIATES NOR THEIR OFFICERS, DIRECTORS, EMPLOYEES, AGENTS, CONTRACTORS OR OTHER SUPPLIERS MAKES ANY WARRANTIES OR GUARANTEES WITH RESPECT TO THE SITES, INCLUDING WITHOUT LIMITATION, WARRANTIES REGARDING THE ACCURACY OR COMPLETENESS OF ANY CONTENT, OR WARRANTIES OF MERCHANTABILITY, NON-INFRINGEMENT OF INTELLECTUAL PROPERTY, TITLE OR FITNESS FOR A PARTICULAR PURPOSE. Bank of America, ITS AFFILIATES AND SUCH PERSONS SHALL NOT BE LIABLE TO YOU FOR ANY LOSS, COST, DAMAGE OR OTHER INJURY, WHETHER IN CONTRACT, TORT, NEGLIGENCE OR OTHERWISE, ARISING OUT OF OR CAUSED IN WHOLE OR IN PART BY (I) CLIENT’S USE OF OR RELIANCE ON THE SITES, OR (II) Bank of America’s PERFORMANCE OF ITS OBLIGATIONS UNDER OR IN CONNECTION WITH THESE TERMS AND CONDITIONS. Bank of America DOES NOT REPRESENT, WARRANT OR GUARANTEE THAT THE SITES WILL BE FREE FROM ERRORS OR WILL BE AVAILABLE. FURTHERMORE, Bank of America WILL NOT BE LIABLE FOR ANY DELAY, DIFFICULTY IN USE, INACCURACY OF INFORMATION, COMPUTER VIRUSES, MALICIOUS CODE OR OTHER DEFECT IN THE SITES, OR FOR THE INCOMPATIBILITY BETWEEN THE SITES AND FILES AND THE USER’S BROWSER OR OTHER SITES ACCESSING PROGRAM. NOR WILL Bank of America BE LIABLE FOR ANY OTHER PROBLEMS EXPERIENCED BY THE USER DUE TO CAUSES BEYOND THE Bank of America’s CONTROL. IN NO EVENT WILL Bank of America, ITS OFFICERS, DIRECTORS, EMPLOYEES, AGENTS, CONTRACTORS OR OTHER SUPPLIERS BE LIABLE TO YOU OR ANY THIRD PARTY FOR ANY PUNITIVE, INCIDENTAL, CONSEQUENTIAL, SPECIAL OR SIMILAR DAMAGES, EVEN IF ADVISED OF THE POSSIBILITY OF SUCH DAMAGE.

    Because some states or jurisdictions do not allow the exclusion or limitation of liability for certain damages, in such states or jurisdictions, the liability of the Bank of America, its officers, directors, employees, agents, contractors or other suppliers shall be limited in accordance with this agreement to the extent permitted by law.

    Neither Bank of America, its Affiliates nor any of their officers, directors, employees, agents, contractors or other suppliers shall be liable in any way, and you agree to indemnify and hold harmless Bank of America, its Affiliates and such persons for (1) any inaccuracy, error, or delay in, or omission of (a) any information on the Sites, or (b) the transmission or delivery of any information on the Sites; (2) any loss or damage arising from or occasioned by (a) any such inaccuracy, error, delay, or omission, (b) non-performance, (c) interruption of use of the Sites due either to any negligent act or omission by Bank of America, its Affiliates, their officers, directors, employees, agents, contractors or other suppliers or to any "force majeure" (i.e., flood, extraordinary weather conditions, earthquake, or other act of God, fire, war, insurrection, riot, labor dispute, accident, action of government, communications, power failure, or equipment or software malfunction) or any other cause beyond the control of the Bank of America, its Affiliates, their officers, directors, employees, agents, contractors or other suppliers. You understand that Bank of America accepts no responsibility for security of information on the Internet.

    UK CONDITIONS

    Banc of America Securities Limited has approved the Sites for the purpose of Section 57 of the Financial Services Act of 1986. Banc of America Securities Limited is regulated for the conduct of investment business in the United Kingdom by the Securities and Futures Authority Limited. No access to the Sites shall be given in the United Kingdom to Private Customers, as that term is defined under the rules of The Securities and Futures Authority Limited; and any investments will not be made by us to any Private Customer.

    CHANGES TO AGREEMENT

    Bank of America may make changes to this Agreement at any time, without prior notice to you. Your continued use of the Sites indicates your continued agreement to be bound by this Agreement, as changed from time to time. You should view these Terms and Conditions often to stay informed of changes that may affect you.

    GOVERNING LAW

    This Agreement shall be governed by and construed under the law of the State of New York and the Federal law of the United States. You hereby consent and submit to jurisdiction in the Federal or state courts of the State of New York, U.S.A. You hereby irrevocably waive your rights to a jury trial.

    THIRD-PARTY LICENSORS

    The Sites may, from time to time, provide Client with various licensed programs ("Licensed Programs") from third-party vendors ("Vendors") which have been licensed by Bank of America for Client use and/or which require Client to sign a third-party license agreement ("License Agreement"). In using the Licensed Programs, Client agrees that it will

    • protect any confidential information of Bank of America, its Affiliates or Vendors contained in the Licensed Programs;
    • restrict the use of the Licensed Programs by Client solely to conditions agreed upon in the Agreement and the License Agreement;
    • restrict the copying of Licensed Programs to that number reasonably required for Client use and backup purposes
    • include Bank of America and Vendor copyright and all other proprietary notices in the use of all Licensed Programs;
    • prohibit the sale, relicensing, leasing, rental, lending and transferring of Licensed Programs;
    • prohibit, and take reasonable measures to prevent, the decompiling, disassembly, reverse engineering or modification of Licensed Programs;
    • comply with all export laws in respect of Licensed programs;
    • disclaim any liability on the part of Vendors for damages, liabilities, costs or expenses incurred by Client in the use of License Programs; and
    • make all vendors a third-party beneficiary of all Client waivers, disclaimers, limitation of liabilities, confidentiality and IP provisions contained in the Agreement.

    MERRILL LYNCH, PIERCE, FENNER & SMITH – FURTHER INFORMATION

    "Bank of America Merrill Lynch" is the marketing name for the global banking and global markets businesses of Bank of America Corporation. Lending, derivatives and other commercial banking activities are performed globally by banking affiliates of Bank of America Corporation, including Bank of America, N.A., member FDIC. Securities, strategic advisory, and other investment banking activities are performed globally by investment banking affiliates of Bank of America Corporation ("Investment Banking Affiliates"), including, in the United States, Merrill Lynch, Pierce, Fenner & Smith Incorporated and Merrill Lynch Professional Clearing Corp., both of which are registered as broker-dealers and members of FINRA and SIPC, and, in other jurisdictions, by locally registered entities. Merrill Lynch, Pierce, Fenner & Smith Incorporated and Merrill Lynch Professional Clearing Corp are registered as futures commission merchants with the CFTC and are members of the NFA. Investment products offered by Investment Banking Affiliates: Are Not FDIC Insured • May Lose Value • Are Not Bank Guaranteed.

    © 2017 Bank of America Corporation

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