The current environment is interesting for the banking sector. While just about every bank has been forced to take big pandemic-related writedowns, the economy seems to be on the mend now (although there is still plenty of wood to chop to reach pre-COVID-19 levels). This means we are close to the point where the whole sector can flip from out of favor to in favor.

Wells Fargo (WFC -0.39%) and Citigroup (C -1.70%) are two of the biggest banks in the U.S. If the worst has indeed passed for the banking sector, which one would make a better investment? 

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Citi vs. Wells: Different business models

Citigroup is more of a "money center" bank. It specializes primarily in credit cards and has a major overseas presence. Investment banking activity and securities trading are a major source of revenue. Citi is far more leveraged to the global economy than Wells Fargo, whose focus is more domestic and whose main business is mortgages. With the mortgage origination business in the midst of a once-in-a-decade refinancing boom, Wells was the No. 3 mortgage lender in the U.S. last year, recently dethroned from its perch by Rocket (aka Quicken Loans) and United Wholesale. That said, Wells is still a dominant player in the space, and could be lifted by its exposure to this part of the economy.

Trying to compare the two on earnings right now is difficult because Wells took a gargantuan $9.5 billion provision for credit losses in the second quarter. The consensus for 2020 earnings is breakeven. Citi is expected to earn $3.30 per share this year, which means the stock is trading at a price-to-earnings ratio of 15.4 (as of Thursday's close). Citi trades at 8.4 times expected 2021 earnings, while Wells trades at 11.5 times expected 2021 earnings. Wells cut its quarterly dividend from $0.50 to $0.10, so its yield is about 1.7% compared to Citi's yield of 4%. Citi has much better expense control, as measured by its efficiency ratio of 52.7% compared to Wells at 81.6%. Given Wells' quarterly loss, comparing return on assets or equity doesn't really tell the investor much. On a valuation basis, Citi is cheaper. 

Wells has regulatory issues

Wells has a regulatory cloud over its head for past consumer problems including the fake-account scandal. The Fed has put an asset limit on the bank, and it has a big target on its back. Regulatory and compliance issues have dogged the bank for years. Recently, Wells was accused of putting mortgage borrowers into forbearance plans without permission. The last thing the bank needs is another scandal. Until Wells can get out of Washington's doghouse, it remains a risky investment. Note that Warren Buffett recently reduced Berkshire Hathway's position in Wells to only 3.3% of the company. This means that even though Wells is beaten up, Buffett obviously doesn't think it represents a value. Berkshire increased its holdings in Bank of America, so this is more of a company-specific issue, not necessarily a statement on the banking sector. 

If the economic fallout from the COVID-19 crisis is indeed over, then the banks are ripe for investment. A rule of thumb for the banking sector is to buy once the writedowns are over. Once the writedowns are finished and the benefit from falling interest rates start to flow, the sector becomes investable. The August jobs report showed that unemployment is falling and jobs are being created, but we still have a long way to go until we get back to normalcy.

It is hard to take a view on the banks quite yet, and if I were seeking financial exposure I would look to the mortgage sector, which is experiencing a massive boom. Certainly if I had to choose between Citi and Wells, it is an easy choice. Wells just has too many headaches and distractions to be a buy. Buffett seems to agree.