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Too big to fail, but not too big to break up

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At Citigroup's annual meeting last week, a shareholder proposal to explore a breakup was left off the agenda. The U.S. bank got a reprieve from the Securities and Exchange Commission, which ruled that the wording of the proposal was vague, and it did not need to be included. Management still fielded questions about whether keeping the bank intact was the best way to maximize returns.

The same day, U.S. lawmakers introduced legislation that would impose strict capital requirements on banks deemed too big to fail. The confluence of events emphasizes the unease that lawmakers and taxpayers still feel about the prospect of more bailouts and the impatience of investors for returns now that banks have regained their footing.

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Dodd-Frank Act includes measures to wind down big financial institutions without tapping taxpayers, but the sheer size of some banks has left many unconvinced. The London Whale losses at JPMorgan also raised questions about whether some banks have become too big to manage. The new legislation would require those with more than $500-billion (U.S.) of assets to hold capital equal to 15 per cent of assets. Faced with that, some banks may simply decide to break themselves up.

Meantime, the U.S. universal banks trade at discounts to some smaller, more focused peers on a price-to-tangible-book basis. And break-up values seem attractive. CLSA, for example, puts a sum-of-the-parts valuation of $72 on Citigroup versus a market price of $47.

Citigroup counters that it has already shed non-core assets and it is cutting 11,000 jobs. But chairman Michael O'Neill says "dismembering [the bank] in an uneconomic way" would not be in the best interest of its shareholders. The likes of Citi, JPMorgan and Deutsche Bank argue that there are still real benefits to universal global banking.

For now, the too-big-to-fail legislation does not seem to have much traction. Lobbyists are out in force. Still, if politics does not break up banks, then investor greed might – unless banks can boost their returns.

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