On Eve of Earnings Season, Should Banks Restructure?

In banking, size matters, but in deciding which banks can benefit from some restructuring size is only a single factor for consideration.

That’s one of the tenets of a note published Monday by sell side firm KBW, which posited that the “too big to fail” measurement is not the only (nor the most effective) tool in the toolbox with which to take the measure of a bank. The drumbeat from observers of the industry has been increasing for there to be at least consideration of breakups to help unlock shareholder value.

The analysts at KBW said that returns on various income statement and balance sheet line items are to be considered as to whether banks are utilizing their operations most efficiently and whether they should restructure across a group that includes Bank of America, Wells Fargo, JPMorgan Chase and Morgan Stanley, among others. By way of example, Bank of America and Citi are trading at multiples of book value at below 0.6x.  KBW has in the past, notably in March, called for a Citigroup breakup, arguing that such a move could boost shareholder value by as much as 57 percent.

As Barron’s noted, beyond the headlines that are tied to the presidential campaign and even the op-ed pages, many banks have seen their stock prices listing on exchanges for below tangible book value.  That roster includes Citigroup and Bank of America.  However, Wells Fargo has traded above tangible book value, if all of those aforementioned names are to be viewed across the past five years.

With the stock trading above tangible book value, the end result is that the company is consistently creating returns above what is known as the cost of capital and is thus generating positive results for its operations and by extension shareholders.  Conversely, said the folks at KBW, Citi has not traded above tangible book value across the same timeframe, which is “a clear market signal that the company should consider much more radical restructuring to create a profitable business that can grow.”

Generally speaking, said KBW, the dismal returns that have been seen at the largest banks means that credit creation in the US economy has in fact been limited, and within the microcosm of the stock market means that restructuring must be considered.