The case for cutting some big banks down to size
While Wall Street critics such as Democratic presidential candidate Bernie Sanders have long called for a breakup of the nation's largest banks, most stock analysts have generally argued that bigger is better when it comes to financial institutions.
However, now challenging that view are two prominent Wall Street analysts, Fred Cannon of Keefe Bruyette & Woods and Mike Mayo of CLSA.
To be sure, Cannon and Mayo differ from Sanders, who regularly lambastes big banks as "too big to fail" behemoths whose very size threatens America's economy and undermines democracy. By contrast, these two analysts' concerns center on the subpar financial performance of Citigroup (C), Bank of America (BAC) and Morgan Stanley (MS).
But souring investor sentiment on the banking sector, dovetailing with the political scrutiny of Wall Street, could put big banks under more pressure to slim down.
Citigroup's share price, in particular, has been a laggard. The New York-based financial services firm's shares have posted a gain of only 9.5 percent over the past five years, underperforming peers, which have all posted double-digit returns, and the S&P 500, which rose more than 53 percent during that time.
According to Cannon, Citigroup hasn't traded above tangible book value, a closely watched measure of profitability, for five years. That means the market doesn't think it can earn back its cost of capital. Bank of America and Morgan Stanley have had similar struggles, though not to the extent of Citigroup.
"That creates bad things for shareholders and bad things for the banking industry when a huge part can't attract new capital into it," said Cannon, who is also the firm's global director of research and chief equity strategist. "We see these big global banks unable to generate what I would call adequate returns on capital."
During a conference call last month at which Citi discussed its latest financial results, Mayo, who has been one of the top-ranked banking analysts on Wall Street for 20 years, suggested that the bank could boost its investment returns by selling its Mexican subsidiary, Banamex, perhaps using the money to repurchase stock. Citi flatly rejected the idea, with chief executive Mike Corbat describing the Mexican business as "strategically important."
"And simply selling the furniture to liberate some capital here, we don't think is the right long-term or intermediate-term decision," he said.
Mayo, a longtime industry critic who attends shareholder meetings to hold boards accountable, also has called for Bank of America to shed its Merrill Lynch unit, which it acquired at the urging of the federal government during the height of the financial crisis. A BofA spokesman declined to comment.
"If you had a Mayo Axiom, the Mayo Axiom would say if a bank has generated low returns for an extended period and the chance for good returns is not likely over the foreseeable horizon, then all options should be on the table," Mayo said.
In the analysts' view, better-performing banks such as JPMorgan Chase (JPM), Wells Fargo (WFC) and Goldman Sachs (GS) don't need to be broken up solely because of their size even, though they are too big to fail. That's because they're operating far more safely now than they did before the crisis, thanks to stronger regulations.
Favoring a more aggressive approach is Neel Kashkari, president of the Federal Reserve Bank of Minnesota and a former Goldman Sachs banker who oversaw the $700 million government rescue of the financial services sector. He advocates breaking up the banks and is hosting a series of seminars on the issue.
Others, such as former Federal Reserve Chair Ben Bernanke and his successor Janet Yellen, have recently came out against a breakup. Veteran banking analyst Richard Bove also questions the wisdom of such a policy, describing it in an interview as "perhaps one of the dumbest ideas that have ever come up."
"Americans love to do business with their big banks," Bove said, "and they also love to say 'let's break them apart so we can lose the products we get from them, and we can pay more money for banking services.'"