The former chairman of Citigroup (C) - who was the architect of the 1998 mega-merger between Citicorp and Travelers Group and its subsidiary, Salomon Smith Barney - called this week for the equivalent of readoption of the Glass-Steagall Act.
The provisions of Glass-Steagall, which stem from the Banking Act enacted in 1933 at the end of the Great Depression, imposed banking reforms intended to control speculation. The Act limited commercial banks' securities activities and affiliations between commercial banks and securities firms. Weills' alliances caused President Bill Clinton to declare, "The Glass-Steagall Act is no longer relevant."
In March of 2009, Citigroup Inc qualified as a financial holding company, among the first to take advantage of the new Gramm-Leach-Bliley Act, the Financial Services Modernization Act signed by President Clinton in November 1999.
Undoubtedly, many wish Mr. Weill had reached the conclusion that giant diversified banks are too big, sooner, as the lack of bank regulation and creation of "too-big-to-fail" institutions were the proximate causes of the 2008 financial crisis.
Weill now suggests that the best way to make money as a bank is as a "pure-play company" that can operate consumer and proprietary units without fear of running afoul of new regulations. Certainly, that might improve bank valuations. The three largest U.S. diversified banks with both commercial and investment banking operations trade well below their peers that lack these operations.
Without consideration to the macroeconomic impacts of breaking up the big banks, investors in these companies surely would benefit from splitting their operations. Citi, BofA (BAC) and JPMorgan (JPM) trade either at or well below tangible book value. Relative to the SPX, this group of three, combined with Morgan Stanley (MS) and Goldman Sachs (GS), have underperformed so far this year by 2%. From their October 2011 lows, their price performance has been positive by 14% but has underperformed the SPX by 7%. Meanwhile, the Large Cap Regionals and Mid-Caps are significantly off their lows and outperforming the index for the year.
These combined commercial banks/investment companies need to listen actively to their investors and take action to avoid being targeted by activist investors who will force the changes necessary to build shareholder value.
The deck is stacked against the big banks right now because growth is slowing, Europe's financial health remains a giant question mark, and investors are nervous. The issue of regulatory reform - in an election year when nothing is likely to be resolved - continues to loom over the group. That, too, translates to uncertainty for investors, who therefore loathe committing.
Michael Mayo, an analyst at CLSA LTd., recently wrote that Morgan Stanley is trading at less than half of its liquidation value and could double if broken up. While Morgan Stanley is relying on a strategy of shrinking some of its operations and reducing riskier assets, Mayo calls for stronger action. The firm's second quarter results bear him out, as results significantly lagged consensus due to a reduced top line. The 5-year historical growth rate for Morgan Stanley is a negative 16.5% according to Zack's Investment Research, and the firm's risk level is rated above average. The shares are trading on a price-to-book ratio of 0.4 x - about 70% below the industry average of 1.3 x.
Investors already have perceived the attractiveness of regional and mid-cap banks, and have priced in to the big banks' share prices the risks and uncertainties under which they labor. Managements of the underperforming companies need to give financial engineering a serious look because they cannot grow their way out of the current situation. Nor can they cut their way to stellar profitability. They should consider restructuring their capital in ways that can be better appreciated by the market, giving their investors the enhanced performance they seek.
Perhaps most importantly, the managements of these firms need to listen to investors and clearly articulate their plans for increasing shareholder value. Otherwise they risk becoming the targets of activist investors - who aren't hesitating to take on the big guys. Just look at Procter & Gamble (PG) for evidence of that.