Market headlines have been dominated in past weeks by a potential Deutsche Bank AG (USA) (NYSE:DB) collapse and its systemic risk to the global financial system. DB’s woes, along with the scandal at America’s largest bank by market capitalization, Wells Fargo & Co (NYSE:WFC), has renewed public interest in breaking up the biggest bank stocks.
The market seems to perceive a government-driven big bank breakup as bad news for bank stocks, but breakups might actually go a long way in unlocking shareholder value.
Turning Up the Heat on Bank Stocks
A number of Wall Street analysts have suggested that big bank stocks should consider splitting up on their own as a strategy to combat lagging share prices. It’s been eight years since the financial crisis, yet BAC and Citigroup still trade below tangible book value.
Back in January 2015, Goldman Sachs suggested that JPM stock could see 25% upside if the company split into up to four different public companies.
In March, Keefe, Bruyette & Woods analyst Brian Kleinhanzl projected that a Citigroup breakup could produce nearly 60% upside for Citigroup stock.
Analysts at JPMorgan, Wells Fargo and CLSA have all been making the value argument for years.
This year, there has been a surge in activist investor interest in breaking up financial stocks as well. Carl Icahn has publicly called for American International Group Inc (NYSE:AIG) to break its business into three companies.
Activist investor Bartlett Naylor has been calling on the board members of BAC, JPM and Citigroup to form committees to study the potential impact of breakups.
The Benefits of Breaking up Bank Stocks
Bank breakups make a lot of sense. Politicians like Bernie Sanders and Elizabeth Warren have made big banks their primary campaign targets. Not only would breakups be good PR for Washington, it would likely reduce the amount of bank-bashing on the campaign trail and in the media.
By shrinking down, bank stocks can also avoid some of the suffocating regulations that have weighed on margins. Earlier this year, Metlife Inc (NYSE:MET) announced a spinoff of its retail business. The spinoff allowed the parent company to avoid Systemically Important Financial Institution status. SIFI designation comes with a huge amount of regulatory headaches. Other big banks and financial institutions may soon follow Metlife’s lead.
Finally, the WFC fraud debacle highlights yet another advantage of breakups. Smaller, simpler banks with more specialized balance sheets paint a much clearer picture of investment risks. One of the major reasons that big bank stocks are so cheap is because the big banks lack transparency. Massive, convoluted balance sheets leave investors uncertain about what is actually going on inside such large, complicated companies.
Don’t Fear the Breakup
Big bank investors shouldn’t worry about potential breakups.
First of all, it’s unlikely that the government will step in and force the issue. If you’re worried about Hillary Clinton or congress breaking up banks, ask yourself one question. How often do politicians actually do what they say they’re going to do?
Breaking up the banks would be a legal and regulatory nightmare for Washington. I seriously doubt any politician actually wants that mess on his or her hands.
Second, if the banks decide to break up on their own, it will likely be very good news for shareholders. The banks wouldn’t pursue a radical move like a breakup unless they were confident that it would unlock value. In fact, in the current low interest rate environment, any news about breakups could be the best reason to buy bank stocks these days.
As of this writing, Wayne Duggan did not hold a position in any of the aforementioned securities.