There are a lot of reasons to like the Financials sector (XLF) right now. U.S. economic growth is picking up, which has spurred Fed rate hike expectations once again. Rising interest rates benefit bank profitability, as banks make money lending at the longer-end of the interest rate spectrum from deposits earning a much lower interest rate. In essence, banks make money off the spread. Rising rates widen the spread.
That’s been the bet of most investors for some time now. In the past six months, the Financials sector is up +19%, trouncing the S&P 500’s impressive gain of +12% over that same period.
If you want to play this macro trend (but get more bang for your buck), you don’t want to buy shares of $235 billion big bank behemoth Bank of America (BAC). What you want to do is buy the much smaller, $18.5 billion Northeastern regional Citizens Financial Group (CFG), says Hedgeye Financials analyst Josh Steiner in the video above from The Macro Show.
“Citizens has been this diamond in the rough with good management… [who’s been] steadily executing on an improvement plan to move from an overcapitalized, inefficient bank.”
For a more thoughtful and detailed breakdown of the divergent investing set-up between Bank of American and Citizens Financial Group, with supporting data and contrarian wit, watch Steiner’s explanation in the video above.
But here are the key takeaways:
In addition to its improvement plans, Citizens Financial Group has “better than average sensitivity to Fed tightening, and better than average loan growth.” The company could also see some goodies out of Washington, DC, if the Trump administration can fulfill its tax reform promise. As a full U.S. taxpayer, Citizens doesn’t realize any tax shelter from having foreign subsidiaries. Any corporate tax reform would directly benefit the company.
Contrast this with Bank of America.
Because BofA is a conglomerate, and derives revenue from more channels than a regional bank, big banks get less bang for their buck when the Fed raises rates. As Steiner points out, Bank of America gets about 50% of its revenue from net interest income, versus 73% for Citizens. On the tax side, BofA also benefits less than Citizens if the Trump administration passes tax reform because of its foreign operations.
Bigger picture, Steiner has some interesting thoughts on the regulatory side of the equation. A recent Supreme Court ruling over a case between Bank of America and the City of Miami, for instance, elucidates why “big banks have forever been unable to get out of their own way since the Great Recession.”
Finally, there’s been increasing chatter down in Washington, D.C. to break up the big banks. Once again, Steiner offers his non-consensus insights: “There is a massive conglomerate discount embedded into all of these big money center banks,” he says. “If we ever do go down that path, it would be an incredibly profoundly positive development and these companies would be worth a lot more than they are right now.”
