Until recently, the question was how can America break up the big banks. Few even questioned the assumption that this would be bad for shareholders. In shocking news, Sandy Weill the architect of Citigroup Inc. (NYSE:C), also called for the break up of big banks.
Mike Mayo, analyst at Credit Agricole Securities, believes that the banks could be worth more split up. Mayo thinks that it would not only be in the best interests of tax payers, but also shareholders themselves. Mayo told Bloomberg that MS stock could be worth “$16 to $32” a share in a breakup. Famous value investor Michael Price also believes that the break up of banks such as Goldman Sachs Group, Inc. (NYSE:GS) would create shareholder value. The analysis is based on sum of parts (SOTP) Shares of Morgan Stanley (NYSE:MS) are currently trading at $14.93 at the time of this writing.
Now Morgan Stanley (NYSE:MS) has come to the defence of the banks (and themselves as well). Today, the giant investment bank put out a long research report showing that banks will be worth far less under a break up scenario. Morgan Stanley (NYSE:MS) has many required disclosures in the report, but it is hard to imagine that the bank is impartial since their head would be next!
Morgan Stanley (NYSE:MS) thinks that the sum of parts valuation are misleading for several reasons Sum-of-the-parts valuations suggest upside of 26% for Bank of America Corp (NYSE:BAC), 38% for JPMorgan Chase & Co.(NYSE:JPM), and 51% for Citigroup Inc. (NYSE:C).
But while these valuations make sense for the current business model, they are too high in a break-up value scenario because:
1) Synergies would be lost, detracting from valuation. Revenues could decline as cross-sell is eliminated and expenses likely rise in each business as savings from sharing overhead costs are eliminated.
2) More liquidity needed as stand-alone business.
3) More capital needed as stand-alone business.
Without mention names, Morgan Stanley explains why they felt the need to put out this report, stating:
We undertake this analysis given renewed discussion by industry participants, some of whom advocate for bank break-ups to simplify operations, reduce systemic risk, and enhance value to shareholders.
Morgan Stanley (NYSE:MS) notes that the managements of Bank of America Corp (NYSE:BAC), JPMorgan Chase & Co. (NYSE:JPM), and Citigroup Inc. (NYSE:C) have said break-ups would require more capital for stand-alone businesses, create frictional costs and reduce scale efficiencies and ability to service customers. A break up would reduce Morgan Stanley’s estimates of the banks between 26-33% as shown below in the graph:
Some of the key assumptions from Morgan Stanley (NYSE:MS) are as follows:
Liquidity
Bank of America Corp (NYSE:BAC) and JPMorgan Chase & Co. (NYSE:JPM) could each require incremental liquidity of about $8b (about 2% higher liquidity levels) if the banks were broken up. This could translate into a 1% hit to EPS.
Synergies and Revenue
Lost Synergies Could Reduce Earnings by 18%. Revenue cross-sell synergies account for 13% of revenues for JPMorgan Chase & Co. (NYSE:JPM), 9% for Bank of America Corp (NYSE:BAC) and 9% for Citigroup Inc. (NYSE:C). This equates to about 18% of earnings for JPMorgan Chase & Co. (NYSE:JPM), 15% for Bank of America Corp (NYSE:BAC) and 13% for Citi, which would likely be at risk in a bank break-up scenario.
A potential spin-off of Banamex by Citigroup Inc. (NYSE:C) is one example of value destruction.
Morgan Stanley assumes that Citi could potentially raise $23.8b by spinning off Banamex. The valuation estimate is the median implied by
P/B and P/E valuation methodologies as we apply peer multiple of 11.6x P/E on their estimated 2013 earnings and 2.1x current book value. MS assume sBanamex’s 2013 earnings comprise about 50% of our overall Citi LatAm earnings forecast of $3.9b.
Capital
Despite the banks having ‘plenty of capital’, this is not the case with a break up.
If the entire bank were broken-up, we estimate the money center banks would require 10-15% incremental capital, which would raise share count by 9-20% and reduce EPS by 8-17%. Currently, Basel 3 capital ratios are about 8% as of 2q12 for Bank of America Corp (NYSE:BAC), Citigroup Inc. (NYSE:C), JPMorgan Chase & Co. (NYSE:JPM) and on a glide path towards 9.5%+ which Morgan Stanley estimates they’ll hit by 4q13.
Morgan Stanley (NYSE:MS) concludes that the best solution would be; getting the ROE up by lowering housing costs associated with the crisis. Banks still need to work through the higher operational costs associated with housing and higher (but declining) credit costs. This is likely to take a few more years. Also, the banks need regulations finalized so managements can optimize their capital allocation, balance sheets, and resources.
(Disclosure: No positions in any securities mention)
