What Is a Universal Bank, and How Does It Make Money?

In this clip, Industry Focus: Financials host Michael Douglass and Fool.com contributor Matt Frankel discuss the three large universal banks –- Bank of America (BAC 1.41%), Citigroup (C 2.53%), and JPMorgan Chase (JPM 1.17%). Here's what these banks do and how they make their money.

A full transcript follows the video.

This video was recorded on Jan. 29, 2018.

Michael Douglass: What's a universal bank, and how is it different from another kind of bank?

Matt Frankel: You pretty much have three kinds of banks. You have commercial banks, which are your typical savings and loans. Wells Fargo is a good example of this. Most of their business is simply taking in money as deposits and loaning it out to customers and profiting from the spread between them. On the other hand, you have investment banks like Goldman Sachs and Morgan Stanley. They do M&A advisory, they do trading, they have equity and debt underwriting. They're the banks that are behind the IPOs that you hear about. Universal banks kind of do both. They do traditional commercial banking, which is why a lot of listeners probably have accounts at Bank of America, Citigroup or JPMorgan Chase. And they also do investment banking activities. They all have big wealth management businesses, they participate in advisory and underwrite debt and equity offerings and have big trading desks, which is where a lot of their assets are, as we'll get to in a minute.

Douglass: Right. The first place you can see this is by looking at their income statement. You look at each bank's income statement and it will tell you that there are different revenue types. All in cases, between 41% and 49% of their revenue comes from consumer banking. 41% for Bank of America, 49% for Citigroup, 48% for JPMorgan.

Frankel: Yes. The rest is spread among various either commercial or investment banking activities. Bank of America, they name their business segments weird, so if you're looking at their income statement it might be a little tough to figure out what's what. But to run down, consumer banking is obviously what you just referred to, with the 41%. They have another one called global wealth and investment management, which is their brokerage business and things like that. Global banking is the M&A portion of their investment bank, M&A and underwriting. And then you have global markets, which is their trading desk. They break it into two. Whereas the other ones are pretty straightforward if you're reading an income statement. Citi's is called the institutional clients group, which refers to all of their investment banking stuff. JPMorgan's is actually called the corporate and investment bank, so obviously that's what that's talking about. Bank of America is the only one that doesn't have straightforward names to their business segments. So, just keep that in mind if you're reading any earnings reports in the future from these three banks.

Douglass: Right. The key takeaway here is, they all have similar-ish revenue mixes. I mean, sure, Bank of America has 23% of their revenue coming from global banking, whereas JPMorgan, on the commercial banking side, which is their most equivalent, is 9%. But it's all pretty similar. These are universal banks, meaning that their consumer banking is the largest individual part of their revenue mix, but they have substantial percentages elsewhere.

Frankel: Yeah, definitely. All three are also pretty similar in size. Citigroup is the smallest of the three, if you can even use that world, with a little over $1.8 trillion in assets. JPMorgan is the biggest with a little over $2.5 trillion. But when you really think about it, that's not that big of a range. These are all comparable banks in size.

Douglass: I was about to say, what's $700 billion between friends?

Frankel: [laughs] Right. They're all also pretty similar in terms of the amount of money they loan out. All three have about a third of their assets in loans, give or take. All three have all the loans well covered by deposits. So, for the most part, they're loaning money from low-cost deposits, just like most commercial banks do. The rest of their assets are mostly tied up in their trading desks. All three are comparable in terms of efficiency of the business. We've talked about efficiency ratio before. They're all within a couple of percentages of each other. And all have grown at pretty much the same rate over the last couple of years. All three had either 6% or 7% loan growth over the past year, revenue was between 1% and 3%. So it's not like one is really outpacing the other three. They're actually all pretty similar, which is kind of an ongoing theme here.

Douglass: Yes. Something we talked about right before hand was ... of course there are differences, but when you're looking at these from a really long-term investing standpoint, really broadly, it's not an enormous difference at this snapshot in time. A couple of points that I'll note. Matt, as you pointed out, their loans are well covered, or over-covered, if you will, by deposits. They have more in deposits than they're loaning out. But because of all those securities, they're also having to take on debt of one kind or another. And debt is about the size, equivalent to about a third or half of their deposits. So, that's sort of that additional money they're taking in to juice up their balances so they can then take on securities and things like that. Efficiency ratio, as you pointed out, between 58% and 62%. Remember that 60% is the number that you want to see, and you want to see lower than that where possible. Bank of America is a little higher, Citigroup and JPMorgan are a little bit lower. But that's how that all works.

Now, thinking about the next part of Anand's framework which is, how much money are they making and how are they making that money, to me, this is where things get really interesting. Of course, as we've talked about a couple of times, I don't know if anyone noticed, these are universal banks. [laughs] I think we've said that a couple of times now. And as a result, net interest income, while a substantial proportion of their net revenue, isn't their entire net revenue. And in some cases, it's really about 50-50 between net interest income and non-interest income, which is a different thing than you would normally expect if you looked at mostly your regional and relatively small-cap banks.

Frankel: Bank of America and JPMorgan are actually almost 50-50, a little bit in favor of interest income. Citi is about two-thirds interest income and one-third non-interest income. And to clear it up, non-interest income is things like advisory fees, wealth management fees, pretty much anything other than them profiting from the difference between money they're loaning out and money they're taking in.