Falling fee income, tough regulations, and shareholder pressure could make diversified banks spin-off their retail banking units, argues Edge Consulting COO Ryan Mendy

Regulators worried about the size and complexity of banks that are too big to fail might get a market solution to their problems, at least according to The Edge Consulting Group, which expects diversified banks to start spinning off their commercial banking divisions in the next few years as the best way to increase shareholder value.

Diversified Banks matrix

Diversified banks already ‘Parmesan shaving’

The Edge Consulting Group COO Ryan Mendy points to the flows out of active management into passive products as trend that will keep putting pressure on investment banks, something that we’ve already crop up as weak fee income growth. Diversified banks have already started cutting back on some of their businesses to satisfy regulators and preserve capital, but Mendy says that’s just ‘Parmesan shaving’ when the banks should be rethinking their entire model.

He points to the lower valuations and lower ten-year returns of diversified banks compared to commercial banks as evidence that spin-offs would be great for investors. Mendy also says that he has talked to activists who would like to press for change, but have held back because of the obvious difficulties: the banks’ size, complexity, intense regulatory oversight, and the conflicts that would arise if you pick a fight with a major broker.

Diversified banks to watch for a possible spin-off

Despite the difficulties, Mendy is convinced that the big bank spin-offs are coming, and that they’re about two years away from being openly discussed. For investors who agree with the basic thesis, he recommends looking for banks that have gotten hit with major fines in recent years (take your pick), and have switched up their management to include people with experience in successful restructurings. If new management has been buying shares in the open market, that’s an even better sign that a spin-off could be in the medium-term plans.

Three specific banks to keep an eye on are Deutsch Bank, HSBC, and UBS. HSBC has already considered doing a spin-off, and even though it hasn’t happened that shows a willingness to revisit the idea in the next few years, and UBS had similar plans, although it was thinking about spinning off its investment banking division instead of retail banking. The argument for watching Deutsche Bank is less direct – it’s in the process of overhauling its IT infrastructure which would be a natural time to reconsider corporate structure in general.