Bank of America's Biggest Competitive Advantage

It may not seem like it right now, but Bank of America has a potent competitive advantage that will fuel profits at the nation's second-largest bank for years to come. I'm referring to it's unrivaled share of domestic deposits.

At the end of the first quarter, Bank of America held a staggering $1.19 trillion in domestic deposits. That was more than any other U.S. bank. JPMorgan Chase came in second, with $1.17 trillion in domestic deposits, followed by Wells Fargo, with $1.11 trillion.

Together, these three banks control a third of the country's total deposits.

This matters because banks generate income in large part by borrowing money at low short-term interest rates and then investing the proceeds in higher-yielding assets such as loans and government securities. And no source of funding that is cheaper than deposits.

You can see this by comparing the cost of Bank of America's deposits to the cost of its other principal sources of funds:

Source: Bank of America's 1Q15 earnings supplement, page 12.

In the most recent quarter, the North Carolina-based bank paid 0.08% interest on its domestic interest-bearing deposits. On top of this, roughly 40% of its domestic deposits were non-interest-bearing, meaning that they didn't cost the bank anything -- other than, of course, the overhead to run its expansive branch network. By contrast, Bank of America paid 2.2% interest on its long-term debt and 1.01% on funds borrowed overnight from other banks.

While having a large stash of deposits is always beneficial, this will be particularly true when the Federal Reserve gets around to raising short-term interest rates. This follows from the fact that Bank of America's assets -- principally, its loans -- are expected to reprice faster than its deposits.

Bank of America's latest 10-Q even provides an estimate of how much higher rates will fuel profits. It shows that a parallel increase in short- and long-term rates of only 1 percentage point will boost the bank's annual net interest income by $4.6 billion. That's a lot of money when you consider that Bank of America earned only $3.3 billion in total throughout the first three months of the year.

In turn, while you'd be excused for questioning whether Bank of America will ever be able to compete against the likes of Wells Fargo or JPMorgan Chase when it comes to running a highly profitable bank, its pole position in the race for deposits gives it, at the very least, a fighting chance.

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John Maxfield has no position in any stocks mentioned. The Motley Fool recommends Bank of America and Wells Fargo. The Motley Fool owns shares of Wells Fargo. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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