Big Bank Breakup On The Way

| About: Bank of (BAC)
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Summary

Are we getting closer to a big bank breakup?

Possibly - as politicians are now chomping at the bit to make an example of Wall Street.

BAC looks most poised to get the activist treatment.

Bank of America (NYSE:BAC) is one step closer to a breakup. The big bank will soon feel pressure from the federal government, as the politicians gear up their push to reinstall Glass-Steagall. Last month, I talked about BAC being a breakup target, but we could be even closer after both political parties have voiced support for Glass-Steagall, which could mandate a system-wide breakup of too-big-to-fail banks.

Breakup Bound

The Brexit and the seemingly forever low interest rate environment continue to weigh on BAC - now down 15% in 2016. But BAC reported earnings this week that beat on the top and bottom lines. But are earnings really getting any better? Earnings beat expectations by 25% despite the fall in revenue, as the bank continues to find new ways to cut costs, with staff cuts leading the way. The glimmer of hope is that BAC has seen its charge off and delinquencies fall yet again. Trading revenue was a positive, but let's not get ahead of ourselves.

The Calls Get Louder

The calls for big bank breakups, namely BAC, are growing louder as the Republicans rolled out their platform to overhaul Wall Street this week. The latest is a plan to reinstate Glass-Steagall to help get the big banks broken up. The idea of Glass-Steagall is to keep commercial lending separate from trading. The rule was dropped in 1999, thanks to Bill Clinton, and banks have been growing gangbusters since then with international expansion and getting into derivatives and capital markets.

But with Donald Trump showing interest in breaking up the big banks this week, with the reinstatement of Glass-Steagall, he hopes to avoid the crisis that leads to 2008. Trump has also been against Dodd-Frank, where a repeal would make bank expansion and growth even easier.

Glass-Steagall has a long history, with there being many calls to bring it back since the financial crisis. The goal is to prevent another too-big-to-fail situation by forcing big banks to shed their riskier activities and focus on the good ole American business of traditional banking.

Things get interesting when you consider Hillary Clinton's history with Wall Street. More importantly is Clinton's potential running mate - Senator Elizabeth Warren - who's Glass-Steagall's biggest proponent. Warren has gone as far as to sponsor legislation that would reinstall Glass-Steagall. The Democrats' platform calls for an update to Glass-Steagall and possible breakup of banks that pose a systemic risk.

Even without a full reinstatement of Glass-Steagall, the fear could be enough to jump start banks in the right direction. Bank of America has already faced proposals from shareholders to forcibly break up the company.

Pseudo Activist

Bartlett Naylor, who runs the consumer advocacy group Public Citizen, has been vocal about breaking up BAC. Right now, he is a pseudo activist on the company. Yet, his stake hasn't been big enough to entice, or excite, fellow shareholders.

Naylor's proposal to breakup BAC didn't even make it to the 2016 shareholder meeting, as Naylor failed to meet the ownership requirements, which include continuously holding 1% or $2,000 in company shares for at least one year.

Naylor did get his proposal for a BAC breakup to the shareholder vote in 2015, but only 4% voted for it. The idea, and Naylor might be onto something with, is to get BAC to divest its non-core banking businesses.

The problem is that none of the "big" activist investors have mustered the strength to target the big banks. We have two activists in the Bank of New York (NYSE:BK) - Nelson Peltz's Trian and Mick McGuire's Marcato Capital. One wants to break the company up; the other thinks things are going well. Needless to say, I'm avoiding that situation at all costs.

But of note, Michael White, the newest BAC board member, is an advisor to activist hedge fund Trian Partners. White is an idea man, where his job is to find potential investments for Trian.

The Split Thesis

I'm coming around to owning BAC. Assuming BAC can get closer to 80% of book value, the upside is $18 to $19 a share. The fast and simple catalyst for BAC would be a spin-off of Merrill Lynch. The bigger goal is to get BAC's trading business, which is performing nicely, from the banking units. Ideally, a BAC breakup helps do away with any sum-of-the-parts discount, plus reduces regulatory overhang and compliance costs. Getting out from under regulatory burdens is a hot trend these days; case in point, AIG (NYSE:AIG) and MetLife (NYSE:MET).

BAC may have moved from simply too big to fail to too big to manage. With a return on equity of below 6% and return on assets at 0.6%, BAC is the worst performer of the mega banks and still trades at a deep discount to book value. Many of the biggest banks are bigger now than they were when the federal government bailed them out during the financial crisis. But major shareholders will remain asleep at the wheel unless we have a unifying force like Trian Partners to get involved.

Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in BAC over the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.