June 30, 2012 (TSR) – Seventeen years ago fund manager Michael F. Price spurred the merger of Chase Manhattan Corp. and Chemical Banking Corp., creating what was then the biggest U.S. bank and laying the foundation for JPMorgan (JPM) Chase & Co.
Now he has a new message: It’s time to break up.
The stocks of five of the six biggest U.S. banks — JPMorgan, Bank of America Corp. (BAC), Citigroup Inc. (C), Goldman Sachs Group Inc. (GS) and Morgan Stanley (MS) — are languishing at or below tangible book value. That means the pieces are worth more than the whole, Price said.
“Within the banks are wonderful assets,” said Price, who sold his fund-management company for $610 million in 1996 and now runs MFP Investors LLC in New York. “How long are the boards of directors going to stand by and take no action and let them be pounded? So far there’s no indication that any of these banks or boards of banks is willing to do anything about it.”
Politicians and regulators have resisted calls from some investors to split up conglomerates that were assembled over two decades by executives such as former Citigroup Chief Executive Officer Sanford “Sandy” Weill and former Bank of America CEO Ken Lewis. These universal banks offered customers everything from checking accounts and insurance to derivatives trading and merger advice. The 2008 financial crisis and subsequent performance of the companies is calling that into question.
Some investors, tired of unpredictable losses, costly regulation and legal headaches, have abandoned the banks in favor of more focused lenders such as Wells Fargo (WFC) & Co. and U.S. Bancorp. (USB) Bank of America has traded below book value since 2009, while New York-based Citigroup has done so since 2010, according to data compiled by Bloomberg.
“It is not clear why a bank needs to do lots of activities in financial services that aren’t banking,” Ken Fisher, CEO and founder of Woodside, California-based Fisher Investments, which manages about $44 billion, said in an interview. “It is not clear to me, other than perhaps in some very specialty cases, that being a bank helps you be an investment bank or an asset manager or an insurer.”
JPMorgan and Citigroup would be worth more broken up,David Trone, an analyst at JMP Securities LLC in New York, told Stephanie Ruhle and Erik Schatzker in a June 22 interview on Bloomberg Television’s Market Makers.
“The universal bank model is broken,” Trone said.
There’s little sign that market forces are changing the universal-banking strategy. Corporate raiders or potential takeovers don’t provide the same impetus for banks as they do in other industries. Laws prohibit non-financial firms from buying lenders, and banks can’t make purchases that give them more than 10 percent of U.S. deposits. JPMorgan, Bank of Americaand Wells Fargo were already at or above that level at the end of March, according to data from the Federal Reserve and the companies.
Some banks have gotten bigger since the financial crisis. The Fed, U.S. Treasury Department and other regulators supported JPMorgan’s purchase of Bear Stearns Cos. and Washington Mutual Inc. in 2008, as well as Bank of America’s acquisition of Countrywide Financial Corp. and Merrill Lynch & Co. JPMorgan’s balance sheet has increased 49 percent to $2.3 trillion since the end of 2007. Bank of America’s assets have grown 27 percent to $2.18 trillion in the same period.
Citigroup, the third-biggest bank by assets after JPMorgan and Bank of America, was given more federal aid during the crisis than any other U.S. bank. Its $1.94 trillion balance sheet is 11 percent smaller than at the end of 2007.
After the crisis, policy makers, politicians and former bankers began calling for a breakup of too-big-to-fail banks. They’ve included former Citigroup co-CEO John Reed, U.S. Senator Sherrod Brown, an Ohio Democrat, former Federal Reserve Bank of Kansas City President Thomas Hoenig and Dallas Fed President Richard Fisher.
Morgan Stanley became the biggest U.S. securities firm in 1997, when it agreed to be acquired by Dean Witter, Discover & Co., a brokerage run at the time by Philip J. Purcell. Purcell, who oversaw the combined company until a revolt by some shareholders and former employees led to his departure in 2005, now thinks that breaking up the banks would be better for shareholders, according to an opinion piece in yesterday’s Wall Street Journal.
“The market is now discounting the stock prices of financial institutions with investment banking and trading,” Purcell wrote in the piece. “Breaking these companies into separate businesses would double to triple the shareholder value of each institution.”
Morgan Stanley CEO James Gorman said in an interview today with Bloomberg Television’s Schatzker that he disagrees with Purcell.
“This is a knee-jerk discussion that’s been going on,” Gorman, 53, said. “We need to just calm down, let this play out with new regulation, the new capital rules, and at that point then figure out which businesses to accelerate, and which businesses to slow down.”
Former Fed Chairman Alan Greenspan, commenting at New York’s Council on Foreign Relations in October 2009, said he thought breaking up the banks might make them more valuable.
“In 1911, we broke up Standard Oil — so what happened?” he said. “The individual parts became more valuable than the whole. Maybe that’s what we need to do.”
That wasn’t the course taken by Greenspan’s successor, Ben S. Bernanke, and Timothy F. Geithner, who led the New York Fed before President Barack Obama appointed him Treasury secretary. They supported legislation that allowed the banking conglomerates to remain intact and sought to address the risks of future collapse by requiring them to hold more capital, submit to new regulations and prepare living wills to help the government dismantle them in the case of a calamity.
The five biggest U.S. banks accounted for 52 percent of the industry’s assets in 2010, up from 17 percent in 1970, according to a report this year by the Dallas Fed. Four banks account for 93 percent of the notional derivatives holdings in the U.S. banking system, according to the Office of the Comptroller of the Currency. Wells Fargo, the fourth-biggest U.S. bank, made 33.9 percent of the mortgage loans originated in the first quarter, the highest share ever recorded and more than triple its closest competitor, according to Inside Mortgage Finance.
To Ira M. Millstein, a senior partner at New York law firm Weil Gotshal & Manges LLP and a veteran antitrust attorney, such statistics indicate that the Federal Trade Commission and the Justice Department should view banking conglomerates the same way the government once looked at Standard Oil — as an anti- competitive oligopoly.
“This kind of size or concentration is something that antitrust always looks at,” Millstein said at a March 27 conference in New York on financial risk and regulation. Instead “we’re simply allowing regulators who missed the boat the first time to try again with even more regulation.”
When JPMorgan last month disclosed a $2 billion trading loss, it reignited concerns that a bank with $2.3 trillion of assets has too much risk for managers and regulators to monitor.
“I just don’t see how you manage those kinds of institutions effectively,” Gary Stern, a former Minneapolis Fed president, said at a June 14 Bloomberg Link conference in Boston. “But I think the responsibility for dealing with that is principally with the management and boards asking themselves: What businesses should we really be in?”
Price, Trone and other advocates for breaking up the biggest lenders cite new regulatory burdens, including Basel Committee on Banking Supervision capital requirements and the Dodd-Frank Act, as core threats to profitability.
“They worked well together in the old world,” said Price, 61, who forecast in August 1995 that the merged Chase and Chemical would become a $100 stock. Shares soared to more than $138 before splits in 1998 and 2000. “That was the analog world. This is the digital world.”
Those regulatory constraints will become even tighter after the JPMorgan trading loss, according to Trone, who calls the biggest U.S. banks “uninvestable” because of new regulation and risks from the European sovereign-debt crisis. Dodd-Frank’s so-called Volcker rule, which restricts trading at deposit- taking banks, will be such a limitation on profits that “market forces” will lead companies to split off trading and investment banking from deposit-taking, Trone said.
That isn’t happening at two of the market’s worst performers: Charlotte, North Carolina-based Bank of America, with 278,688 employees as of the end of March, and New York- based Citigroup, with 263,000.
“Our customers need us to do this, and that’s why we do it,” Bank of America CEO Brian T. Moynihan, 52, told investors on a May 30 conference call to explain why his bank needs to be in consumer and corporate and investment banking. Vikram Pandit, Citigroup’s CEO, said the bank’s “central mission” over its 200-year history has been “to support economic progress.”
“We’re going to continue to serve our clients by putting our unique capabilities to work for them,” Pandit, 55, said in defending the bank’s model during an April 16 conference call.
That hasn’t been serving shareholders. Over the past five years, those two stocks were the worst performers in the 24- company KBW Bank Index (BKX), dropping 84 percent and 95 percent, respectively. Bank of America is trading at about 60 percent of its tangible book value, while Citigroup is at 52 percent, according to data compiled by Bloomberg. Tangible book value is the best estimate of what shareholders would get if all of the banks’ assets were sold and its liabilities paid off.
By contrast, a bank a fraction the size — Minneapolis- based U.S. Bancorp, with $341 billion in assets — chalked up the third-best performance in the KBW Bank Index and is trading at 2.6 times tangible book.
JPMorgan, led by former Weill protege Jamie Dimon, 56, is trading at about tangible book value even after posting record profit for 2011. Wells Fargo, its smaller and more U.S.-centric competitor, is valued at 1.72 times tangible book.
“That’s a valid question, we should look at it,” Dimon, JPMorgan’s CEO, said at a Feb. 28 investor event when asked if the bank would be worth more broken up. “But I can’t imagine that the units of this company would perform better if they were parts of a much smaller company.”
Marc Lasry, the billionaire co-founder of Avenue Capital Group LLC, said on Bloomberg Television today that banks will have a difficult time making money in coming years and weak stock performance could lead boards to make changes. Davide Serra, the former head of European bank research at Morgan Stanley who is now managing partner at Algebris Investments, said on television today that the universal bank model “has through time been the winning one.”
Spokesmen for Bank of America, Morgan Stanley and Goldman Sachs declined to comment on whether their boards are considering breaking them up. A JPMorgan spokesman didn’t return calls seeking comment. Jon Diat, a spokesman at Citigroup, said in an e-mailed statement that the bank has been profitable for more than two years and that its presence in emerging markets and history of helping finance trade make it well-suited for today’s economy.
“We know what trends will define the global economy,” Diat wrote. “We have positioned our company to seize and capitalize on nearly all of them.”
Fisher, who said he has been underweight bank stocks compared with benchmark indexes for three years, sees another explanation for why banks stick to their model.
“The inherent nature of a lot of CEOs is to love empire building,” Fisher said. “The ones that love empire-building will do whatever he or she can to dissuade the board of directors” from breaking their companies up.
High compensation for bank CEOs and their boards of directors is another reason they’re resistant to change, according to David Ellison, president of FBR Fund Advisors Inc. in Arlington, Virginia, and chief investment officer of FBR Equity Funds.
A pay package for Pandit that would have awarded him about $15 million for 2011, along with a retention plan that could be worth about $40 million, was opposed by shareholders this year in a non-binding advisory vote. Citigroup’s non-employee board members received between $56,250 and $625,000 in 2011, including a mix of cash and stock, according to the company’s proxy.
“The motivation is not there really,” Ellison said at the June Bloomberg Link conference. “They’re not going to do it unless they’re forced to do it.”
Managements and boards also are protected from market forces in ways they wouldn’t be at industrial conglomerates, said Amar Bhide, a professor at the Fletcher School of Law at Tufts University. Regulators won’t permit leveraged buyouts of banks, and the largest U.S. lenders are too large to be candidates for LBOs, he said.
“Unless somebody comes in and says, ‘Aha, this bank is trading so far below book value that I can come in and break it up and sell the pieces,’ what’s the incentive for the boards of directors?” Bhide said. “Banking is an industry where these things are simply not allowed.’”
Because regulators only allow banks to acquire banks, eventually some of the smaller lenders, perhaps supported by private-equity companies as shareholders, could attempt to acquire parts of the larger conglomerates, Fisher said.
“The ant will swallow the elephant and disgorge the pieces,” Fisher said. Regulators are unlikely to balk at such a deal “if the avowed purpose is to set the bank to banking and the other pieces off on their own.”
In April 1995, when Price’s Heine Securities Corp. became Chase Manhattan’s biggest shareholder and said the bank’s stock wasn’t being properly valued, Chase took action. Its $10.9 billion merger with Chemical four months later created the biggest U.S. bank at the time, with almost $300 billion in assets. Price reaped a profit.
About 18 months ago, Price said on a Bloomberg Television interview with Tom Keene that New York-based Goldman Sachs should break itself into separate trading, banking and money- management businesses. Price said the parts could reward Goldman Sachs shareholders, whose stock was then worth about $162, with a value of $250 a share.
Goldman Sachs, with $951 billion of assets, closed yesterday in New York at $91.03, or about 74 percent of tangible book value. Greenhill & Co., which operates as a stand-alone investment bank, is valued by shareholders at more than six times tangible book value. Asset-management companies such as Legg Mason Inc. and Blackstone Group LP (BX) trade at more than six and four times tangible book, respectively.
“I talked about Goldman doing it, and Goldman doesn’t want to hear it,” Price said. “I’m just a small money manager now, so there’s nothing I can do. These are big banks now.”