Hedge funds may try to force banks to break up

Break up big banks?

Some of the banks could be broken up, but it may not be Washington that makes it happen.

Activist investors in need of new targets could be the force that takes behemoth (and often under-performing) Wall Street institutions and whittles them into more manageable operations, or nudges them into mergers and acquisitions.

"Banks are going to be where you'll see activism rise," said attorney Steven Wolosky. He should know. As a partner of Olshan Frome Wolosky in New York, he represents activist investors who take on public companies and agitate for change.

"Institutional investors have seen returns [by encouraging] activists," he said.

The next question is: How big can activists go?

Comerica is the nation's 32nd biggest bank, according the Federal Reserve's count of deposit size, and analysts and activists alike have agitated for change there. The bank's shares were boosted earlier this year, but so far, nothing has come of it.

But there are other signs activists are gaining traction.

In 2014, Nelson Peltz's Trian Management picked up a stake in Bank of New York, and later that year a fund representative was named to the bank's board. It's uncommon, though some say that may not remain the case for long.

"For the first time, you have an activist on the board of a bank," said CLSA banking analyst Mike Mayo, who also went after Comerica's management earlier this year. "U.S. banks are ripe for activism."

Officials at Comerica were not immediately available for comment.

Thanks in part to decades of industry consolidation, the bigger that banks are, the less likely they are to bow to activists — or at least, to an unsolicited bidder.

"As a practical matter, you cannot make a hostile approach to a bank," said Christopher Whalen, senior managing director of financial institutions ratings with the Kroll Bond Rating Agency. "Activism isn't effective with big banks because of the Bank Holding Company Act."

The act is a 60-year-old law that requires the buyer of a large commercial bank to get various approvals from a veritable alphabet soup of regulators, including the Fed, the Treasury Department's Office of the Comptroller of the Currency, the Federal Deposit Insurance Corp. and some state regulators. Whalen suggested it would take up to a year to even get a bid in, never mind getting a target to go along with it.

And then, there's Warren Buffett, the easy-does-it, buy-and-hold investor who owns massive stakes in some of America's biggest banks and who's rarely inclined to go along with a campaign to rattle management's cage. Through his company Berkshire Hathaway, Buffett's clout extends widely among shareholders, and a nod from the Oracle of Omaha is sometimes enough to swing a key vote in a bank's favor.

A representative for Buffett could not be reached for comment.

But many Wall Street banks, Mayo points out, have underperformed even their own modest expectations. He called on investors, activist and otherwise, to implement what he called "the Mayo Rule" — any bank with single-digit return on equity should expect to see an activist calling for change.

Should hedge funds' traditional dividend strategy begin to slow, more may come around to "the Mayo Rule."