Will Depressed Bank Values Force Breakups?
The question of how big is too big when it comes to large financial institutions is nothing new. It is a question that has pervaded the thinking of banking analysts since the financial crisis exposed the weaknesses hidden in universal banks like Bank of America (NYSE:BAC), Citigroup (NYSE:C), and JPMorgan Chase (NYSE:JPM). In recent months, activism has raised awareness among investors and management that a change is needed. As analysts at Wells Fargo wrote a note seen by Bloomberg Thursday, shareholders of these institutions may demand breakups if valuations remain depressed.
Shareholders are more likely to agitate for changes than in prior years, noted CLSA bank analyst Michael Mayo in an April 9 research report acquired by the publication. “Almost every large investor from our meetings and conversations over the past four months agrees that bank managements should be held more accountable and more often intend to vote against directors, compensation plans, and other actions,” he wrote.
Increasing regulations and higher capital requirements imposed on banks by the Federal Reserve and other government agencies following the crisis have been triggers for this wave of activism. “Given the challenges posed by increasing regulation, higher capital requirements, and well-publicized trading/market challenges, it’s not surprising that investors remain reluctant to assign a ‘full’ valuation to the universal banks,” stated the Wells Fargo analysts. “If regulators and/or legislators don’t demand it, shareholders could also intensify demands to ‘break up the banks.’ ”
From their analysis, Matthew H. Burnell and the other Wells Fargo analysts determined that the universal banks like Bank of America, Citigroup, and JPMorgan currently trade at a 25 percent to 30 percent discount to more-focused competitors. In comparison, Goldman Sachs (NYSE:GS) and Morgan Stanley (NYSE:MS), both of which concentrate on investment banking, are within 8 percent of the estimated value of their parts.
When the analysts compared valuations of these banks to the estimated value of their separate pieces, they found that parts of Bank of America are worth 41 percent more than their tangible book value — the total value of the company’s assets that shareholders would theoretically receive if a company were liquidated. According to these calculations, Citigroup should get a 24 percent premium, JPMorgan should get 69 percent, and Goldman Sachs should be valued at 19 percent more than tangible book. However, according to data compiled by Bloomberg, Citigroup — the nation’s third-largest bank by assets — and Bank of America, the second largest, trade at approximately 14 percent and 7 percent less than tangible book value, respectively.
JPMorgan, the largest U.S. bank, and Goldman Sachs, the fifth-largest, trade 28 percent and 9 percent more than tangible book value, respectively. But that valuation compares with the 281 percent premium commanded by U.S. Bancorp (NYSE:USB), the nation’s largest regional bank…
Their note estimated that — based on the sum of their parts — JPMorgan should trade at $64.83, Bank of America should trade at $16.07 per share, Citigroup should trade at $63.33, and Goldman Sachs should trade at $159.59.
While such legislation is unlikely to pass, measures to impose higher capital rules on the largest U.S. banks, such as the bill proposed by Senators Sherrod Brown and David Vitter, would probably cause a break-up of these lenders, according to the analysts.
A more likely scenario, wrote May in his research, is that shareholders in these firms will have to push for the changes. “Almost every large investor from our meetings and conversations over the past four months agrees that bank managements should be held more accountable and more often intend to vote against directors, compensation plans, and other actions,” he stated.
He also criticized a decision made by the Securities and Exchange Commission to allow Citigroup to omit from its annual meeting a proposal by shareholder Trillium Asset Management that would require the bank to consider a breakup. However, as Bloomberg reported Thursday, JPMorgan is already questioning the universal bank model’s future. Top-tier investment banks are “uninvestable at this point with a risk of spinoff from universal banks,” noted JPMorgan analysts led by Kian Abouhossein.