| Illustration by Selman Design |
Politicians and regulators may fret that transnational banking conglomerates are too big to fail. Activist investors, on the other hand, increasingly wonder if they are too big to succeed.
The latest stir has been provoked by Zurich-based activist fund manager Rudolf Bohli and his firm, RBR Capital Advisors. In October, Bohli floated a plan to break his giant neighbor Credit Suisse Group into three parts: a global private bank, an investment bank, and an asset manager restricted to Switzerland. These pieces would be worth twice as much as the current struggling whole, he argued.
Bohli, as a financial David armed with just 0.3 percent of Credit Suisse’s stock, was brushed off by his Goliath target. “All the ideas that are being discussed . . . are not new,” CEO Tidjane Thiam told reporters after third-quarter results that showed a 90 percent year-on-year jump in adjusted pretax income. Brusquely, he added, “We think we are in a better position than people outside the company to make that decision.”
“Management is doing a good job,” David Herro, a partner at Chicago-based hedge fund Harris Associates, the bank’s biggest shareholder, told Bloomberg. He derided RBR as having “hardly any skin in the game.”
Yet Bohli, in a letter to fellow shareholders and an interview with Alpha, presents some arguments that Credit Suisse and its global bulge-bracket rivals cannot ignore indefinitely.
While megabanks struggle to trade at book value, standalone investment banking boutiques like Lazard are worth more than four times book. The giants’ average return on equity is about 8 percent, compared to 15 percent for pure-play asset managers like Charles Schwab and Ameriprise Financial. (Credit Suisse’s ROE just nudged above 3 percent.) The conglomerates’ once-swashbuckling trading floors barely meet the cost of capital given the deluge of post-2008 regulations and the proliferation of less-encumbered hedge funds.
Credit Suisse has shrunk its markets divisions energetically since Thiam’s ascendancy in 2015, but still needs “world-class investment banking” to support its reasserted core business of wealth management, a company spokesman argues. Bohli is unimpressed by the synergy. “The wealth management side has said it has maybe 150 clients who demand these services,” he says. “Does it make sense to have 12,000 traders in London and New York to support them?”
Bohli is not the only investor to smell value in bank disaggregation. Across the Atlantic, Citigroup is in the sights of Mike Mayo, a veteran trouble-making analyst now with Wells Fargo Securities. His research concludes that Citi’s far-flung components are worth two thirds more separately than their current market cap together, which is still 30 percent below its peak in late 2006. His remedy is to split retail from investment banking, sell consumer operations from Mexico to East Asia, and spin off the lagging U.S. retail bank as a new public company. “With Citi saying returns will just reach the cost of capital in 2019, we say a restructuring should at least be considered,” Mayo says. “Having retail in Mexico, Asia, and the U.S.A. under one roof — why is that optimal?”
Bohli and Mayo are following in the rich tradition of their clan. In 2013, Swiss activist Knight Vinke Asset Management raised the topic of restructuring at UBS Group, recommending a divorce between investment banking and asset management. In 2014 redoubtable U.S. investor Nelson Peltz and his Trian Fund Management won a board seat at Bank of New York Mellon on a platform of severing the firm’s private bank from its custodial banking. Yet while these and other disrupters made profits on their stakes, none came close to achieving the desired breakup.
Why not?
The bank managements all argued, in one way or another, that they were already in the midst of wrenching reforms and could not start a second revolution until completing the first. The activists themselves agree to an extent. Mayo predicts Citi’s current course will double its share value over the next five years, though the shakeup he advocates could cut that to three or four. Bohli is fine with Credit Suisse completing the strategy it laid out until the end of next year, then turning more radical.
Sundering complex, interlinked, highly regulated global financial operations would cost money before it saves any, observes Andreas Venditti, an analyst at Zurich-based Bank Vontobel who has worked at both Credit Suisse and UBS. “What Bohli proposes would probably take three to five years for Credit Suisse to execute, and costs would spike during that transition.”
The regulation that frustrates management can also protect it, says Eleazer Klein, a partner at New York law firm Schulte Roth & Zabel who advises activist investors. Banks are subject to intricate limits on concentration of ownership and the number of board seats a single shareholder can attain. As household names, the financial whales also attract a large contingent of retail investors, who are particularly difficult for activists to mobilize. And, of course, the “Trump trade” in equities generally, and financial stocks particularly, has relieved pressure over the past year.
A few exceptional organizations like JPMorgan Chase & Co. might benefit from being everywhere and doing everything, but as an organizational form, the global megabanks showed their scary vulnerabilities in 2008. They have not re-established a convincing raison d’etre in the decade since: New regulations provoked by the crisis keep making it harder for them to earn money for their shareholders. “Banks like to argue that size brings economies of scale, but many academic studies show that it doesn’t really,” Venditti says. “Cost-to-income ratios are not lower in larger operations.”
That fallacy will presumably become more apparent to more investors whenever the next market downturn comes. Perhaps then bank boards will take activists’ breakup plans more seriously.
