Shareholders of JPMorgan Chase (NYSE: JPM) and Citigroup (NYSE: C) will soon get to vote on a shareholder proposal seeking to break-up the mega banks. While the proposal is not likely to get anywhere, it does highlight growing concern that the banks might be too big to manage.
Today, Keefe, Bruyette & Woods analyst Brian Kleinhanzl weighed in on the matter. He believes that Citi could be one of the only U.S. global systemically important bank that could successfully split up and said this should unlock meaningful shareholder value – 50+% returns versus the current market capitalization.
The analyst believe that the primary motivation for splitting up would be the faster return of excess capital to shareholders. He said in current form they expect Citi will utilize the deferred tax asset (DTA) over time and this will create excess capital. However, they believe meaningful return of the excess capital will be difficult given the current and expected regulatory environment that Citi faces. “We fully believe that regulators are more than comfortable having capital build at the largest banks, and adding G-SIB surcharges into the stress test process will be the next leg up in capital requirements,” he commented. “Therefore, if Citigroup management wants to return excess capital after the DTA is utilized and Citi Holdings wound down, then the clearest path to doing so is via a corporate reorganization.”
Kleinhanzl said one of the primary benefits of becoming smaller is escaping the vice that is the current regulatory environment.
“We have made conservative assumptions and yet there is a path for Citi to improve the company’s valuation by almost 60% versus where the combined company trades currently,” he said. “The anticipated benefits from restructuring should offer a meaningful return to shareholders, and valuation multiples should improve over time since Citi post-split could return to meaningful growth as well.”
Bottom line, the analyst said while their argument for breaking up may fall on deaf ears at Citigroup, they believe they have outlined a credible path that C could take to unlock value. “In our minds, Citi is making an assumption that regulators will be open minded about future capital returns and we think this could be a mistake,” he said. “Thus far, G-SIBs have only seen increases in required regulatory capital and we expect that to continue. We believe that investors could own two companies with a combined market cap of almost $190 billion if Citi were to split up. In the end, we believe Citi management will do what is right for shareholders, but splitting should be an option considered.”
Below is a table illustrating the potential value creation opportunity from a split: