The past month has been a tough one for financial companies. While the Federal Reserve has taken extraordinary measures to support the stalled economy that was created as part of efforts to halt the spread of the coronavirus pandemic. Real estate investment trusts (REITs) and banks have been thrown overboard as the economy jerks to a halt. What does this mean for two of the biggest banks in the United States?
JPMorgan Chase (NYSE:JPM) and Citigroup (NYSE:C) are what used to be referred to as the "money center banks," which were the big Manhattan banks that served the biggest blue-chip clients. Both entered 2020 enjoying a benign economic environment with low interest rates and multi-decade lows in defaults. Now that the COVID-19 pandemic has taken control of the economy, how does that change things? And which big bank is better equipped to handle such a crisis?
The government just upended the mortgage space
The first thing to consider when comparing these two operations is mortgage exposure. Under the CARES Act, the government has permitted homeowners to defer mortgage payments for six months, with the option to defer another six months without interest penalties, late fees, or credit reports. Borrowers do not have to prove any sort of hardship -- a statement saying they have been affected is enough.
This rule applies to all mortgages backed by the government, whether Fannie Mae, Freddie Mac, Veterans Administration, Federal Housing Administration, or Department of Agriculture. New York, California, and Connecticut have required all banks to provide 90 days of no payments for all loans that do not fall into that category. It's likely most states will do something similar. Note that the state actions only apply to loans not insured by the government, which largely means jumbo loans (over $510,400). These are the types of mortgages that big banks like JPMorgan and Citi like to hold as portfolio loans.
Mortgage servicing is the next shoe to drop
Given that there will be no financial penalty for taking advantage of the program, most people will operate under the "a dollar today is worth more than a dollar tomorrow" theory. This means that the banks are going to see much of their mortgage book suddenly become non-performing. While the missed payments for most loans are insured, meaning the banks will get them back someday, the non-guaranteed loans may not. Both banks have mortgage servicing books as well, which means they will be on the hook to advance principal and interest to the ultimate investors when the borrower stops paying. This will create an enormous drain of cash.
Commercial mortgage-backed securities (CMBS) are another major issue. Many businesses are closed, and commercial property tenants are probably paying reduced (or no) rent. The ratings agencies have been taking down their ratings on numerous retail, hotel, and office CMBS, and more will be coming as this situation evolves.
Valuation and performance
Below is a table of the relevant valuation numbers for the two banks. JPMorgan has always traded at a premium multiple compared to the other big four banks (including Bank of America and Wells Fargo). Citi has always traded at a lower multiple. JPMorgan trades at a premium for a reason -- it has better return on assets and return on equity ratios. JPMorgan's stock price has weathered the current crisis better than Citi as well. Year to date, JPMorgan stock is down about 40%, while Citi is down 54%.
|ROA||ROE||P/E Ratio||Dividend Yield|
This is not 2008
It is important to remember that this situation is not like the financial crisis of 12 years ago when the banking sector came dangerously close to collapsing. Regulatory changes made in the aftermath of the crisis (stress testing, additional capital requirements, etc.) have made the sector much more able to withstand the type of economic shock we are experiencing right now. We are also not experiencing a bursting residential real estate bubble, which is the Hurricane Katrina of banking. While serious, the COVID-19 crisis is nothing like the 2008-09 crisis, at least in terms of its impact on the financial sector.
Unfortunately for the sector, the time to own the banks (or start a position in banking stocks) is when the asset writedowns are finished, not before they even start. I wouldn't want to own either of these bank stocks quite yet.
With 14% of assets in mortgages and a large servicing book, JPMorgan is particularly vulnerable now that the government has rewritten the rules of the mortgage market. Too much uncertainty over the mechanics of this move makes it hard to recommend. Citi has a lot of overseas exposure, and Europe was in trouble before the coronavirus even hit. While both banks should weather the crisis, troubled waters lie ahead. The financial sector is a falling knife at the moment. Tread carefully.