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Should I Buy Bank Stocks During the Coronavirus Crash?

The U.S. economy has been largely shut down as a result of the COVID-19 pandemic, and the stock market has taken a beating. Even after rebounding significantly from the March lows, the S&P 500 is still down by 27% from its mid-February closing high.

One of the worst performing sectors in the market has been the financials, down by 37%. And all of the "big four" banks have done even worse. JPMorgan Chase (NYSE: JPM) has fallen by 39% since mid-February, and Bank of America (NYSE: BAC) is 42% lower. Wells Fargo (NYSE: WFC) has shed 44% of its share price, and that's after underperforming the financial sector for several years following the infamous fake accounts scandal. And Citigroup (NYSE: C) has been hit especially hard, down by 52% since the market plunge began.

Image source: Getty Images.

Why have bank stocks fared so poorly?

To be clear, there are some good reasons for the poor performance in bank stocks.

For one thing, interest rates have plunged to record low levels. The benchmark 10-year Treasury yield is just above 0.6% as I write this, down from nearly 2% at the beginning of the year. Mortgage rates are at historic lows, and other lending rates have fallen as well.

Most banks make the bulk of their revenue by lending money to consumers and businesses and collecting interest. If interest rates plunge, profits tend to drop as well.

Second, and more significantly, the U.S. is in a recession and nobody knows how long the coronavirus outbreak will last or how deep the recession will be. I've seen estimates calling for GDP declines of anywhere from 6% to more than 30% for the second quarter, and they seem to keep getting revised lower.

Not only does a recession (and the shutdown of much of the economy) reduce demand for loans, but since many people have lost income, borrowers could also start to have trouble paying their debts. A sharp increase in defaults could result in big losses for banks.

Are the fears overdone?

First off, there's a great deal of uncertainty right now, and that's harming bank stocks most of all. The COVID-19 pandemic could largely be resolved by the summer, or it could drag on until fall or beyond. We just don't know, so lots of potential bad news is priced into bank stocks.

As JPMorgan Chase CEO Jamie Dimon recently wrote in his annual letter to shareholders, "Of course, we do not know how this crisis will ultimately end, including how long it will last, how much economic damage it will do, or how fast or slow the recovery will be."

However, it's important to take a minute to put things into perspective.

Yes, falling interest rates hurt profitability, but not by as much as you might think. Let's look at Bank of America as an example. From the end of 2018 to the end of 2019, the federal funds rate (the benchmark interest rate the Federal Reserve controls) declined by 75 basis points. Bank of America's net interest yield certainly fell, but only by 17 basis points from 2.52% to 2.35%. So, while the 150-basis-point rate reduction implemented by the Fed in response to the coronavirus crisis is going to hurt bank profits, they aren't exactly going to zero.

On the topic of loan defaults, as long as the government is injecting stimulus into the economy in the form of small business loans, direct payments to U.S. households, enhanced unemployment benefits, student loan postponements, and more, any uptick in defaults is likely to remain manageable.

Plus, banks are much better prepared for a terrible recession than they used to be. JPMorgan Chase recently said that it has run its own "stress test" that uses worse parameters than the Federal Reserve's test -- assuming a 35% contraction in GDP and 14% unemployment -- and the bank would still remain adequately capitalized and with strong liquidity.

Are bank stocks a good buy right now?

To be clear, I have absolutely no idea what the big bank stocks will do over the next few days, weeks, or months. I'd be willing to guess that they'll be rather volatile, but that's it.

However, the banks are trading for incredibly cheap valuations right now. Bank of America is trading for just 72% of its book value, for example, despite tremendous improvements in the quality of its assets and the efficiency of its operations over the past several years. Wells Fargo is trading at a valuation that hasn't been seen since the depths of the 2008-09 financial crisis.

The point is that while the banks may struggle in the current environment, it's tough to make a case against some of the larger, well-run banks at these prices from a long-term perspective.

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Matthew Frankel, CFP owns shares of Bank of America and has the following options: short July 2020 $20 puts on Wells Fargo. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.


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