Bank of America has substantially increased its asset and wealth management business over the last decade, spurred on by its 2008 acquisition of Merrill Lynch as well as the introduction of Merrill Edge, a wealth management product targeted at mass affluent customers.
This is an interesting move, as asset and wealth management businesses offer notoriously low margins compared to other financial products and services. You can see this in the table below, which compares the profit margins of Bank of America's four main operating divisions: consumer banking, global wealth and investment management (GWIM), global banking, and global markets.
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Data source: Bank of America's 3Q15 financial supplement, page 16.
It should be clear from this table that Bank of America's most profitable operating division is its global banking unit, from which it generates an impressive 48% profit margin. Following that are its consumer banking and global markets units, with margins of 35% and 33%, respectively. And trailing far behind is GWIM, which a profit margin of only 23%.
From this comparison, it's obvious that asset and wealth management services aren't only less profitable than Bank of America's other products and services, they're much less profitable, with a combined margin that's less than half as wide as global banking's.
Making up for the lack of margins, however, are three important points. The first is that Bank of America's other business lines benefit from cross selling to GWIM customers. In the first six months of the year, $1.8 billion worth of client assets migrated from GWIM to other business, consisting of deposits, loans, and assets held in brokerage accounts.
The second point is that the GWIM business exposes Bank of America to minimal credit risk -- the risk that loans will default -- the scourge of a bank's existence when the economy takes a turn for the worse. The assets administered by GWIM are "assets under management," and not actually held on Bank of America's balance sheet. The original owners retain title to the assets and bear the risk that they will decline in value.
Finally, revenue from managing assets is typically less volatile than revenue from other types of financial products and services. You can see this in the chart below, which shows the quarterly revenue fluctuations in three of Bank of America's fee-based businesses: cards, investment and brokerage (i.e., GWIM), and trading.
Stability in this regard not only boosts a bank's share price, but it also, at least theoretically, helps a bank perform well on the stress tests administered by the Federal Reserve each year. One of the objectives of the stress tests is to project what will happen to a bank's revenue and earnings in the event of a severe economic downturn akin to the financial crisis. As asset and wealth management revenue is likely to hold up better than other divisions -- and particularly those exposed to credit risk -- it offers a solid foundation upon which to generate capital even when other businesses are burning through it.
In sum, Bank of America's strategic focus on asset and wealth management should, given time, make it a stronger, more profitable, and more reliable company for investors to own shares of, despite the fact that the business line itself offers otherwise dismal margins.
The article Why Does Bank of America Love This Low-Margin Business? originally appeared on Fool.com.
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