America is downsizing. Whether it’s the food we eat, the cars we drive, or the houses we live in, Americans are concluding that smaller is better. Even U.S. corporations are starting to see the benefit of more Lilliputian institutions; the impending –and widely hailed – breakups of McGraw-Hill (MHP) and Kraft (KFT) are two examples.
So what about banks? It would surely be in the government’s interest to downsize megabanks. Sen. Sherrod Brown (D-Ohio) continues to push his bill to split apart the largest institutions. Regulators have new authority to order divestitures under the Dodd-Frank financial reform law. From a shareholder standpoint, government breakups have a pretty good outcome. It worked out well for John D. Rockefeller, whose shares in Standard Oil doubled after it was ordered to break up. Ditto for those who owned stock in AT&T (T).
Yet with gridlock in Washington, don’t count on politicians for a solution. Shareholders, however, have an interest in demanding that big banks split apart. Comparing the valuation for the supersize banks (Citigroup (C), Bank of America (BAC), and J.P. Morgan Chase (JPM)) with their simpler, leaner competitors isn’t pretty. Price/earnings per share for the supersizers averages 5.8, compared with 8.1 for smaller, more focused Wells Fargo (WFC) and 8.1 for the bigger regional banks like U.S. Bancorp (USB) and PNC (PNC). More telling is the ratio of share price to tangible book value. For the supersizers, the average is 72% of book, compared with 165% for Wells and 142% for the big regionals. Chase’s strong performance holds up the average for the supersizers, but even its price to book is only 110%. Wells’ superior performance suggests that complexity is a bigger drag on returns than size is. Even though Wells’ assets exceed $1 trillion, it has pretty much stuck to its basic business of taking deposits and making loans, and in the process has consistently delivered solid returns.
Before the financial crisis, the supersizers benefited from high levels of leverage and cheap debt funding costs from their “too big to fail” status. All that has changed. Capital requirements are going up significantly for mega-institutions. The cost of borrowing will rise, too, as bondholders come to realize that Dodd-Frank means what it says: no more bailouts. New rules on liquidity, proprietary trading, and derivatives will also eat into earnings. So it is hard to see how the megabanks’ numbers can improve.
Supersizers argue that their scale is necessary to meet the financial needs of multinational corporations. But it’s not clear that multinationals find it advantageous to do business with a handful of financial titans. Dealing with smaller, more focused institutions provides specialized expertise and less risk of conflicts. If there were really that much value in supersizer services, presumably it would show up in shareholder returns. But it doesn’t.
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