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Morningstar | Upgrading the Moat Ratings of JPMorgan and Bank of America; Scale, Scope, and the Future of Banking

After an extensive review of the competitive positioning of the big four U.S. money center banks, we are upgrading the moat ratings of JPMorgan and Bank of America to wide, and maintaining the moat ratings of Wells Fargo and Citigroup at wide and narrow, respectively.

We believe it is appropriate to upgrade some of the moats of the largest U.S. banks. This is based on a stronger, more stable U.S. banking system as well the increasing importance of size and scale in banking. We believe the U.S. banking system is much stronger and more stable than it was a decade ago, leaving more room for wide moats among the best-positioned banks. This is due both to the higher capital levels present within the system as well as the regulatory reform that has reduced or eliminated some of the riskier banking activities within the money center banks.

A decade-long period of regulatory reform and capital building is now behind us. The rapid growth of technology solutions within banking should allow the largest banks to focus on more efficient and more profitable product distribution, creating product offerings on a national and even international scale. The shift from defense to offense should allow the largest banks to finally be able to focus on maximizing the value of their own franchises, largely based on scale and economies of scope advantages. The largest banks also have the biggest technology budgets. While absolute technology spend is not the be all end all metric for technology advantages, we believe it will certainly help over the long run.

As such, we see JPMorgan, Bank of America, and Wells Fargo as all having strong individual franchises across multiple product categories. However, we believe there are advantages to combining them all under one banking roof. These banks are better able to cross-sell, provide advantaged pricing, and spread the customer acquisition costs across more revenue streams. Therefore we see each of them as worthy of a wide moat rating.

JPMorgan is the largest U.S. money center bank by assets and tends to have leading share and operations in almost all of the areas it competes. We will not list them all here, but needless to say, JPMorgan often has the leading franchise or one of the leading franchises in almost any banking product available. The bank is particularly strong in I-banking, cards, asset management, and retail household reach. Bank of America is similar, with leading or top tier franchises across the banking industry. We'll highlight the bank's Merrill Lynch franchise, strength in cards, and overall mortgage and deposit gathering capabilities. Finally, while Wells Fargo has run into numerous issues over the past couple years, the bank still has the most comprehensive branch network in the U.S., is still a leading deposit gatherer, has a large advisory network, and has particular commercial strength within the middle market. We highlight all of this to emphasize that each of these banks have individual segments that are strong in their own right.

While all of these segments are strong on their own, we believe there are advantages to combining them all under one banking roof. On the consumer side, each bank is able to cross-sell multiple products, provide advantaged pricing to key customer segments, and spread the overall costs of customer acquisition across more revenue streams. On the commercial side, similar dynamics apply, and each bank is able to offer a complete package with national and/or global scale that few can compete with, while sending out armies of bankers to both existing and new markets in an effort to win new business. Over time, we see a bifurcation between the banks with the most scale, most complete product stacks, and the most advanced technology backbones, and those that do not. We believe each of these three banks is likely to be in the first group.

There are still many threats facing the banks, most notably through technological disruption. We think deposit insurance and regulatory factors still provide a formidable barrier to entry for potentially disruptive competitors. While there is possibly room for some disruption in the more tangential aspects of banking, such as payments, the core functions of being able to hold deposits and having direct access to the banking system are still well protected. Also, the more a company begins to look like a bank, the more likely it is the regulators will eventually step in, as we believe regulators want a transparent and controlled financial system that is largely under their purview. We believe that the pure scale of the largest banks' operations will be tough to match, their technology spend will not make them easy targets, and the fact that the banks already own decades of data and all the key relationships will further increase their ability to withstand disruption. We also see the banks working together whenever something is perceived as a threat to the industry in general, such as through the creation of Zelle. The biggest threat we see would be if a competitor with already existing scale, technological capabilities, and name recognition would step in to the banking industry. The most obvious candidate fitting this description would be a firm like Amazon, but we don't see it wanting to become a regulated bank any time soon. Overall, given the tech budgets the largest banks have, we believe they already are investing to stay abreast of the latest fintech developments and in many cases are even beginning to use them to their advantage.