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Why Bank of America Is Stepping Back from Trading

By John Maxfield – Mar 16, 2016 at 4:20PM

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Bank of America's trading operations lag far behind its other units in terms of profitability.

Bank of America appears to have come to terms with the fact that its high-priced traders can't generate the type of revenue that's long been expected from trading operations. Image credit: iStock/Thinkstock.

Bank of America (BAC -4.26%) is reducing its dependence on trading to generate profits, as it's parted ways over the past few weeks with multiple high-level traders. The move makes sense when you consider that the bank's global markets segment, which houses its trading operations, also happened to be Bank of America's least profitable business line in 2015.

You can see this in the chart below, which compares the return on allocated capital earned by Bank of America's four main operating units. (For the record, the two segments that are excluded from the chart are the bank's legacy assets and servicing division, which is responsible for administering legacy and noncore assets, and its "all other" division, a hodgepodge unit responsible for managing the bank's liquidity and risk management, among other things.)

Based on data from 2015. Data source: Bank of America's 2015 10-K.

The fact that Bank of America's consumer bank is the standout may come as a surprise. This follows from the fact that Wall Street traders are generally among the highest paid people in a financial firm. It would only make sense, in turn, for their operations to also be the most profitable. Meanwhile, the least glamorous business line, consumer banking, generates the highest return on allocated capital despite the fact that it likely pays its employees significantly less than their Wall Street counterparts.

It could be argued, of course, that trading profits are merely experiencing a temporary slump. However, there are two things that seem to suggest this is a more permanent problem. The first is the fact that new laws and regulations -- the Volker rule in particular -- have clamped down on proprietary trading that doesn't involve market making -- that is, buying and selling securities at a customer's behest.

The second thing to keep in mind is that the slump in trading revenues last year was merely a continuation of previous years. To this end, 2016 is already on track to mark the fourth straight year that Citigroup's fixed-income and equity trading revenue falls, says Bloomberg. Citigroup's chief financial officer John Gerspach recently disclosed that the bank expects revenue from the unit to fall by 15% in the first three months of 2016 compared to the same period last year.

This goes a long way toward explaining why Bank of America parted ways with Kevin Connors, the former global head of foreign-exchange sales at the bank, as well as Arnaud Droitcourt, the bank's former head of Asia-Pacific equity trading. All told, Bank of America is purportedly dismissing 150 trading and investment-banking employees.

This may seem like bad news in the short-term, but it may very well make Bank of America a more stable and profitable firm over the long run, as highly profitable banks such as Wells Fargo and US Bancorp seem to prove that traditional, boring banking is the best way to consistently generate outsized returns.

John Maxfield owns shares of Bank of America, US Bancorp, and Wells Fargo. The Motley Fool owns shares of and recommends Wells Fargo. The Motley Fool has the following options: short May 2016 $52 puts on Wells Fargo. The Motley Fool recommends Bank of America. 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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