Early this morning, analysts at Britain-based Atlantic Equities announced a pair of downgrades for each of these American megabanks. In quick succession, first Bank of America lost its overweight rating and got cut to neutral -- and then Citgroup did, as well.
Now you may be wondering: Who exactly is Atlantic Equities? (They're hardly a household name, after all.) Well, according to our data here at Motley Fool CAPS, Atlantic is a middling stock market analyst that ranks only in the bottom 40% of investors we track. That said, Atlantic doesn't appear to publish ratings that often, and we've only got a limited view of its recommendations over the past few years. However, one of these ratings was for Bank of America -- and on that rating, Atlantic successfully beat the market by 6 percentage points.
Does that success make the analyst's recommendations on both Bank of America and Citigroup worth listening to? Decide for yourself. Here are three things you need to know about these downgrades.
Thing No. 1: Energy's the thing
There's been a lot of talk in the media lately about how big banks, who made big loans to oil companies back when the oil market was good, might get hurt by defaults on those loans now that the oil market is bad.
Atlantic expects defaults to hit Bank of America and Citigroup especially hard. According to the analyst, profits could be 8% worse than expected at B of A, and 12% worse for Citi, in 2016.
Thing No. 2: Bad news all around
B of A and Citi won't be the only banks getting hit by bad oil loans. Megabankers JPMorgan and Wells Fargo could get hurt as well. But Atlantic says its downgrades are a "relative call." The implication being, Bank of America and Citigroup will fare worse than their brethren and take larger writedowns on their respective loan portfolios.
Thing No. 3: Atlantic could still be wrong
Granted, this is still just one analyst's opinion. Data from S&P Global Market Intelligence confirm that by and large, most analysts still remain optimistic about both Bank of America and Citigroup. 27 out of 32 analysts polled by S&P Global rate B of A the equivalent of a buy, while 23 out of 29 analysts polled still like Citi -- and for that matter, even Atlantic Equities isn't necessarily saying you need to sell the stock. They only downgraded to neutral.
Meanwhile, even if the analyst is right on its downgrades, you have to admit that there's a whole lot of room for error built into these stocks' prices right now. Historically, you can expect most quality banks to sell for valuations equal or superior to their book values. But at last report, both Bank of America and Citigroup were selling for stock prices just 56% of their book values -- a 0.56 P/B ratio.
And one more thing
In fact, when it comes to Citigroup in particular, the case for buying the stock could be a whole lot stronger than the case for selling. Remember how Costco (NASDAQ:COST) announced last year that it is splitting up with American Express (NYSE:AXP) and shifting its credit card business to Citigroup instead, as the sole provider of Visa cards that will be accepted at Costco stores?
Well just yesterday, we learned that Citigroup has acquired Costco's co-branded credit card portfolio from American Express, in a deal expected to close June 2. The sale looks like good news for AmEx, which is expected to report a $1 billion profit on the sale. But acquiring all those Costco customers -- now Citigroup customers as well -- is going to be great news for Citigroup's business as well, offering not just (minimal) swipe fees, but vast opportunities to cross-sell a variety of other Citigroup financial services.
Given this potential big change for Citigroup's fortunes, Atlantic's decision to cut its rating to neutral alongside Bank of America seems like painting with too broad a brush. These two banks are not created equal. Not only do both stocks look cheap -- but Citigroup might be even cheaper than Bank of America.