The two megabanks that lagged competitors over the course of the bull market run of the past decade, Wells Fargo (WFC -0.68%) and Citigroup (C -0.87%), are outperforming thus far in 2023. Wells Fargo's stock price is up about 13.8% year to date, while Citigroup was up about 14.2%.
Which of these two banks is the better buy for investors?
Wells Fargo is going through some things
Wells Fargo, the fourth-largest bank in the U.S. with about $1.9 trillion in total assets under management, has been dogged by regulatory problems over the past several years. There was a massive fake accounts scandal that was first reported in 2016, and more recently, just in the fourth quarter of 2022, the bank was hit with a $3.7 billion fine by the Consumer Financial Protection Bureau for widespread mismanagement of auto loans, mortgages, and savings accounts.
The fine, along with an increase in the amount the bank set aside for anticipated credit losses, took a bite out of profitability in the fourth quarter. The bank posted a 50% year-over-year decline in earnings with $2.9 billion in net income, or $0.67 per share. Wells Fargo's revenue decreased 6% year over year in the quarter.
While the bank saw a surge in net interest income due to higher interest rates, its revenue took a hit because of a cooling off in mortgage lending. Wells Fargo is one of the largest mortgage lenders in the country, and the slowdown in the housing market had a major impact on revenue. Originations were down about 70% in the quarter compared with the prior-year period, to $14.6 billion.
However, the stock price got a boost in January from the announcement Wells Fargo made just before earnings that it was scaling back its mortgage business to focus on its bank customers, as well as individuals and families in minority communities. In turn, it is exiting its correspondent lending business, which buys third-party mortgage loans, and it's reducing its mortgage servicing portfolio. It is part of the bank's effort to better diversify its portfolio and reduce the risk that comes with the housing market.
Citigroup is executing on some changes
Citigroup is the third-largest U.S. bank with about $2.4 trillion in total assets under management. While earnings in the most recent quarter were down 21% year over year to $2.5 billion, or $1.16 per share, revenue surged 6% year over year to $18 billion and beat analysts' consensus estimates.
Citigroup got a boost in its personal banking and wealth management group, benefiting from higher interest rates. It also saw revenue gains in its institutional clients group. Losses in the investment banking business were offset by gains in the Treasury and trade solutions unit, particularly in the area of fixed-income trading. The drop in earnings primarily came from a higher provision for credit losses, in anticipation of a weakening economy.
CEO Jane Fraser was brought in in March 2021 to turn around the struggling bank, following an accounting scandal earlier that year.
She has thus far been successful in selling off nonperforming assets, particularly in international markets, like the sale in the fourth quarter of its consumer banking operations in Thailand and Malaysia. At the same time, she has boosted the trading business and managed to cut expenses. In the fourth quarter, operating expenses decreased 4% year over year.
Which is the better buy?
Both of these banks are in turnaround mode. At this point, Citigroup is further along in the process and has a more diversified operation. Its issues are more about streamlining operations and strategically investing in its businesses while Wells Fargo, which has always been more consumer banking-oriented, is tasked with bulking up its investment banking and institutional trading businesses. It has made inroads and gained market share, but still has a ways to go.
Citigroup has a lower valuation, with a 7.4 price-to-earnings ratio compared to 15 for Wells Fargo. It has a higher dividend yield at 3%, against 1.8% for Wells Fargo. It is also better capitalized with a common equity tier 1 ratio of 13%, up from 12.2% a year ago, while Wells Fargo is at 10.6%, down from 11.4% a year ago.
Wells Fargo's focus on consumer banking and scaling back of its mortgage business may help it in the short term, as rising interest rates will benefit consumer banks with increased net interest income. It may even outperform Citigroup over the next 12 months, but I think Citigroup is the better buy for the long term with its low valuation and more diversified earnings power.
