March has been a brutal month for financial stocks, as efforts to control the coronavirus pandemic have led to a shutdown of a large portion of the U.S. economy, which has translated into a credit crunch. The Financial Select Sector SPDR (NYSEMKT:XLF) is down nearly 22% since the start of the month, and some sectors such as mortgage real estate investment trusts (REITs) have taken a beating.
Bank of America (NYSE:BAC) and Citigroup (NYSE:C) are both banking giants and their stocks have been affected by the broader market downturn as well. With that said, which one is the better buy right now?
Bank of America: Specializing in mortgages
When you think of Bank of America, think of mortgages. The company holds a lot of them. Between agency mortgage-backed securities, first and second mortgages, and corporate mortgages, 26% of its assets are real estate-related.
Agency mortgage-backed securities are guaranteed by the government, which means the most Bank of America can lose is the premium over par. The non-government guaranteed mortgages held on its balance sheet as portfolio products can go delinquent and lose money. The government is seriously considering enacting a mortgage forbearance program where borrowers affected by COVID-19 can skip their mortgage payments for six months (extendable to a year). Certainly, the non-guaranteed portfolio mortgages will see at least some uptick in delinquencies as a result.
Citigroup: Global banking and credit cards
Citigroup has mortgage exposure as well. However, it is much smaller than Bank of America's. Citi holds about 9% of its assets in mortgages, and again, most of them are government-guaranteed.
Citi's credit card portfolio is much bigger than Bank of America's, comprising 9% of assets. So far there has been no indication that the government will provide for some sort of credit card debt forgiveness program; however, it is inevitable that delinquencies will rise here too, especially if the economic slowdown drags on for months.
Citi also has a lot of overseas corporate exposure. Citi will be more exposed to any sort of European banking contagion emanating out of Italy or Germany.
Key metric comparison
The key metrics for both banks are laid out in the table below. The two appear to be reasonably cheap with mid-to-high single-digit P/E ratios.
|Bank of America||Citigroup|
|Return on Assets||1.14%||0.98%|
|Return on Equity||10.6%||10.3%|
Bank of America has a better return on assets and return on equity than Citigroup. However, last year was great for mortgage investors, with falling interest rates and delinquencies at 40-year lows. With the disruption caused by the virus, delinquencies are going up. Credit card delinquency rates have been creeping up since bottoming out in 2015, but they are still much lower than they averaged pre-crisis.
This is a lousy time to own the banks
If there is one time you don't want to own stock in banks, it is when the country is heading into a recession. Unfortunately, it can be hard to resist the sector because the P/E ratios are based on earnings made while in an expansion, so the sector looks dirt cheap. It isn't.
Generally speaking, the time to own bank stocks is when the inevitable write-downs from recessions are finished, not before they even start. Until the COVID-19 crisis begins to wind down and we can finally draw a line under the economic damage, the banking sector is a falling knife.
That said, we aren't in a situation like in 2008-09 either. As a result of the regulatory changes made in the aftermath of the financial crisis, the banks are much better capitalized. Many of financial products (especially subprime mortgages) at the center of that previous crisis no longer exist. Finally, we don't have a residential real estate bubble, which are the Hurricane Katrinas of banking. While nobody can view the future with certainty, it is hard to envision any sort of bank failures coming out of this crisis, let alone severe issues for Citi or Bank of America. They remain fundamentally safe long-term investments.
Most of Bank of America's mortgage exposure is in government-guaranteed mortgages, which means its biggest risk is getting loans paid out early via refinancing, not delinquencies. Wealth management income accounted for 16% of Bank of America's earnings last year, and that is an incredibly safe and profitable business. Citi has a lot of overseas exposure, and Europe's economy was in trouble before the whole coronavirus problem exacerbated the situation.
I wouldn't own either stock right now, but if I had to pick one, I think Bank of America is safer. And in this environment, safety trumps everything.