A shot was fired across the bow this week on Wall Street: An activist investor bought a large number of shares in Morgan Stanley (NYSE:MS), the nation's sixth biggest bank by assets.
There's a sense that this puts the other big banks on notice, and none more so than Bank of America (NYSE:BAC). But even though there are reasons to think that the North Carolina-based bank makes the juiciest target of them all due to its embarrassingly low valuation, I'd be surprised if an activist investor actually tries anytime soon to force change on the bank from the outside.
Activist investors have lately avoided banks
The threat from activist investors is nothing new. Nor is there anything new about them taking positions in major companies.
Earlier this year, one of the best-known activist investors since the 1980s, Carl Icahn, exited a three-year investment in Apple, netting a $2 billion profit. Whether Icahn's less-than 1% stake in the company was enough to spur change is debatable, but that didn't stop him from lobbying Apple to return more capital to shareholders.
Until now, however, the nation's biggest banks have seemed to escape activist investors' gaze. This is despite the fact that many bank stocks are patently cheap. For its part, Morgan Stanley's shares trade for a 16% discount to book value, meaning that the market values it at 16% less than the shareholder equity on its balance sheet.
Bank of America presents an even more extreme case. Its shares trade for a 36% discount to book value. Indeed, this is why commentators have begun to speculate that it might be the next to attract the attention of activist investors.
Bank of America and activist investors
It's not just random analysts and commentators speculating about this. Here's what The Wall Street Journal's Christina Rexrode had to say about it on Wednesday:
The Morgan Stanley stake, worth about $1.15 billion Tuesday, prompted a flurry of discussions about who might be next. Some Bank of America investors, frustrated by years of low returns, had reached out to activist investors ... to gauge their interest in getting into B of A, according to people familiar with the matter.
Some of these activists saw Bank of America as a possible investment, one of the people noted, but the bank's size makes it hard to accumulate a stake big enough to wield any influence.
Rexrode surely has credible sources telling her this, but I'd say that the aversion among activist investors to Bank of America probably has less to do with size and more to do with the fact that it isn't an easy fix. Icahn asked Apple to distribute more of its cash. What would he push for at Bank of America? After all, the Federal Reserve dictates how much capital it can distribute.
The one thing we know for sure is that an activist investor couldn't just swing into Bank of America's boardroom, push for massive cost cuts, and then triumphantly fly away with fattened pockets. The bank beat everyone to this punch. Over the last five years, it cut operating expenses by $15 billion a year. And CEO Brian Moynihan just committed to cutting $3 billion more by 2018.
There also couldn't be a lot of low-hanging fruit in terms of unloved, noncore subsidiaries for an activist to pry loose in order to free up capital. Bank of America has already culled the ranks of its various businesses, closing or selling dozens of them since the crisis.
From the looks of it, the only opportunity to shake up Bank of America would be to sell off or shutter its trading operations. These reduce the number of high-yielding assets that large universal banks with both commercial and investment banking operations can hold on their balance sheets. They also negatively affect a bank's debt rating, which increases borrowing costs. If you get rid of trading operations, in other words, there's an opportunity to increase profitability.
But the problem with this thesis is that Bank of America's trading operations are intimately intertwined with the other investment and commercial banking products and services that it offers. This goes to a point Moynihan has made in the past, that Bank of America's large customers want access to a full gamut of financial products, including trading. It would thus be very difficult to know in advance whether the reward from offloading its trading operations would outweigh the risks.
In sum, while it wouldn't be impossible for an activist investor to take a pass at Bank of America, it seems unlikely. The unknowns and potential pitfalls are too great. It's for this reason that the recent conversation about interest among activist investors in Bank of America should, in my opinion, have no bearing on an investor's thesis in its stock.