Since the coronavirus pandemic struck the economy, both Bank of America (NYSE: BAC) and Citigroup (NYSE: C), two of the largest banks in the world, have been hit hard. Bank of America’s share price is down roughly 28% from the beginning of the year, while Citigroup’s is down roughly 33%. Meanwhile, the S&P 500 index is only down a few percentage points, suggesting the overall market is still erring on the side of caution when it comes to bank stocks.
For this reason, I am looking for those bank stocks with the least amount of risk, which is why I like Bank of America better than Citigroup. Not only does Bank of America have what I consider to be a safer loan and overall portfolio, but I also believe that the bank’s dividend is much safer than Citigroup’s, which could face some danger of being cut or suspended later this year.
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A safer portfolio
Since they’re both extremely large and complex financial institutions, neither Bank of America nor Citigroup come without risk. But overall, despite having more total assets and a much larger retail bank, Bank of America has less credit card debt. At the end of the first quarter, the company had total credit card loans of roughly $92 billion, compared to Citigroup’s roughly $167 billion. Credit card losses are higher in stable economic environments, but can really spike in economic downturns when people start to get laid off and struggle to pay their debt. This is part of the reason that Citigroup’s ratio for allowance for loan losses (a measure of how much total cash a bank is setting aside to cover future expected loan losses) to total loans is 2.91%, compared to Bank of America’s 1.51% at the end of the first quarter. This makes sense because of the composition of each bank’s portfolio, but it still makes Citigroup susceptible to higher losses.
Bank of America has a larger commercial loan book, and I do think certain segments within that book could be at risk. But I think that’s less from poor credit quality and more a result of recent trends caused by the pandemic. For instance, the trend of working from home could decrease demand for office space, hurting the current values of office buildings, which could hurt existing office building loans on Bank of America’s books. However, I think that if this does affect the bank, it will happen much more gradually, whereas if coronavirus cases spike again and much of the country is forced to essentially lock down, credit card borrowers will default at faster rates.
Another thing worth pointing out is that despite Citigroup’s smaller loan book and heavier focus on other banking segments, Bank of America actually managed to bring in roughly the same percentage of non-interest income as Citigroup in the first quarter of the year.
A safer dividend
In general, large banks like Bank of America and Citigroup have plenty of capital to cover their quarterly and annual dividends. But the banks could be at a higher risk of having to suspend or cut their dividends if they fall below regulatory requirements. For instance, a key ratio regulators scrutinize is the common equity tier 1 (CET1) ratio, a measure of a bank’s core capital that can be used to cover unexpected loan losses against a bank’s total risk-weighted assets. Bank of America must maintain a 9.5% CET1 ratio, while Citigroup must maintain a 10% CET1 ratio. At the end of the first quarter, Bank of America’s CET1 ratio sat at 10.8%, while Citigroup’s was at 11.2%.
However, upcoming bank stress test results set to soon be released by the Federal Reserve could make the minimum thresholds higher. A recent Keefe, Bruyette & Woods (KBW) research note said that if the Fed makes potential economic scenarios more severe in their stress testing and increases the loan losses banks would have to account for in a hypothetical severe economic downturn, Citigroup is one of the few banks that could see its CET1 ratio fall below minimum regulatory thresholds . KBW did not cite Bank of America as one of the banks at risk of dipping below minimum thresholds. If this were to happen, Citigroup would be limited to capital distributions of 60% of eligible retained income, which is defined as the average of the preceding four quarters of net income.
Now, even if Citigroup does dip below its CET1 ratio minimum thresholds, Citigroup’s CFO Mark Mason said on the company’s most recent earnings call that “there is still plenty of room between that and the use of the buffer that the regulators have authorized .” After all, Citigroup’s dividend payout ratio in 2019 was only 23.9% , while its dividend payout ratio in the first quarter of 2020 was 48.6% . So, the bank could still have room to maintain its current dividend. But the mere fact that KBW has Citigroup at risk of falling below CET1 minimum thresholds and Bank of America safely remaining above makes me feel a lot better about Bank of America’s dividend.
Buy Bank of America
Bank of America and Citigroup are two of the largest banks in the world, so rest assured that the government is not likely to let either fail and both have promising futures ahead in the long run. But as of today, I am going with Bank of America because to me it seems like the safer option from a credit perspective and the bank being able to maintain its current dividend.
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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.