Esteemed banking analysts Dick Bove recently came out and stated large money center banks like Bank of America (NYSE: BAC) should be broken up. He makes the point they still present significant systemic risk.
Is Bank of America too big to fail?
The short answer is yes. Nevertheless, we need banks with the size and scale of Bank of America today. Bank of America is currently on a path to success. Furthermore, the bank is still vastly undervalued on a relative and historical basis.
Bank of America is in the midst of effectively executing the end of a long-term turnaround program. By increasing revenues and cutting costs, Bank of America is increasing earnings per share year over year. Keep in mind this has all occurred in an extremely low interest rate environment. If this trend continues, it should pave the way higher for the stock. With the bank’s legal woes solidly in the rear view mirror and interest rates on the rise, I posit the inflection point in the stock is upon us.
Vast size and strength necessary
Breaking up Bank of America just as it is about to break out is possibly the worst idea I’ve heard as of late. U.S. banks need the current size and strength. I submit the vast size of major U.S. banks such as Bank of America, JPMorgan Chase (NYSE: JPM), Wells Fargo (NYSE: WFC), Citigroup (NYSE: C), Goldman Sachs (NYSE: GS) and Morgan Stanley (NYSE: MS) are needed to successfully compete in the global marketplace. The drumbeat to break up the big banks started as a way to avoid another financial crisis comparable to the 2008 debacle. The major problem with this solution is it does not address the actual reason for the crisis in the first place.
2008 Great Recession cause
The 2008 financial crisis was not caused by the banks being too big. The crisis was caused by the failure of a widely held class of assets referred to as residential mortgage backed securities. The U.S. housing market was essentially a massive house of cards which inevitably had to come crashing down. Lehman Brothers, the first big bank to fail, was simply a victim of the crisis, not the cause of it. Breaking up the big banks may cause more harm than good.
Too small to succeed
Breaking up the big U.S. banks may solve the issue of the banks being too big to fail. Yet, breaking up the banks may end up making them too small to succeed in the process. This could have a major deleterious effect on the global economy. As the major economies of the world have grown larger over the years so have the major banks to accommodate these economies.
Large banks needed to compete globally
Bank of America competently expedites trade and investment on an international scale. With the globalization of the world’s marketplaces, large scale banks with substantial liquidity are necessary to handle the large scale needs of international markets. Furthermore, size limits could increase resource costs of providing banking services. This may cause the big banks to discontinue certain programs, in turn decreasing the number of opportunities for profits.
Emerging economies need big banks
Emerging market economies have benefited greatly from big banks. Standards of living have been raised across the board based on these banks providing the financing for major infrastructure projects among other things. For instance, Bank of America has trained nearly 1,200 non-profit executive directors worldwide to help to promote vibrant, safe and economically viable communities across the globe since 2004. Bank of America sponsors many people and programs that are making impacts in the world. Without the cost savings provided by Bank of America’s economies of scale, I suspect many of these programs would not exist.
Fed has strengthened bank balance sheets
The Federal Reserve’s initiative to raise capital levels, increase capital quality, reduce leverage and improve liquidity in Bank of America has been effective. Even though the bank is even bigger than before the 2008 crisis, it is much stronger today. Breaking up the bank may cause issues we haven’t even considered. As the former United States Secretary of Defense Donald Rumsfeld once famously stated:
“There are known knowns; there are things we know that we know. There are known unknowns; that are to say, there are things that we now know we don’t know. But there are also unknown unknowns – there are things we do not know we don’t know.”
I love this statement by Rumsfeld. There are just too many unknown unknowns to undertake such a grand endeavor. I know the current situation may not be perfect, but better the devil you know than the one you don’t.
Bank of America remains undervalued
Even though shares of the bank have rallied significantly over the past few quarters, I posit that there is still more room to run. Bank of America historically trades for closer to two times tangible book value. Currently, the company has a price to tangible book value of slightly over one.
Bank of America is trading at a significant discount to its five-year average. Moreover, Bank of America is trading at a significant discount to most stocks in the S&P 500 and several of its peers at current levels. The stock is a buy at current levels for investors with a long-term time horizon.
The Bottom Line
We need banks of the size and scale of Bank of America to compete in the global marketplace. I see the premise that Bank of America needs to be broken up as false. Furthermore, I do not see this happening with President Trump in control. He has promised to pullback on regulations not increase them. There is no way Trump is going to back breaking up the banks. So I say “go ahead Bove, make my day, just try and break up the big banks.” Those are my thoughts on the matter. I look forward to reading yours.
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Disclosure: I am/we are long BAC.
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.