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Measuring Up Citigroup and Bank of America

Bank of America used to be the stock Wall Street loved to hate. Citigroup, on the other hand, was supposed to be the troubled bank that had finally gotten its act together.

Citigroup Building
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Citigroup Building

Those familiar roles have been reversed in 2012, however, and with bank earnings season set to start later this week, investors will be closely watching to see how the two banks match up.

The two have plenty in common. Both giants were forced to turn to the government for help in the wake of the financial crisis in 2008, and both have chief executives who have spent much of their tenure cleaning up the messes they inherited.

Both companies have also had to issue significant amounts of new stock to raise capital that solidified their balance sheets but left their shares at a fraction of pre-crisis highs. Citigroup and Bank of America also face the risk of a credit downgrade by the ratings agency Moody’s Investors Service in mid-May.

Until last month, it seemed that Citigroup was recovering more quickly. But when the Federal Reserve blocked the company’s proposal to buy back stock and increase its dividend after last month’s stress tests, investors were left wondering if they had bet on the wrong horse.

Bank of America passed all of its stress tests this time around — after its own inability in 2011 to deliver a dividend increase that investors were hoping for — and opted to continue to build capital for the rest of 2012.

Bank of America shares are up 66 percent this year, while Citigroup's have risen 33 percent, amid the broader rebound in financial stocks. After staying out of the spotlight and earning $21 billion over the last two years, Citigroup’s potential problems are gaining attention again. “Citigroup Is the New Bank of America,” TheStreet.com declared after the stress test results were made public in March.

Vikram S. Pandit, the chief executive of Citigroup, and other top officials may still increase the company’s dividend, albeit in the fourth quarter and for less than they initially proposed. Brian T. Moynihan, the chief executive of Bank of America, has made it clear that increasing capital levels and shedding noncore assets, rather than returning capital to investors, are the order of the day for now.

At Barclays, the analyst Jason Goldberg said he was shocked when Citigroup did not get the go-ahead from the Fed, adding, “We had run mock stress tests with Citi passing by a fair amount.”

Just as surprising, he added, has been Bank of America’s surge this year. Its performance has been a far cry from last year, when Bank of America’s stock, which closed at $9.23 on Thursday, was flirting with $5, and questions about whether it had enough capital were mounting.

“If you asked me in January whether this thing would be up 66 percent, I’d have said you’re crazy,” Mr. Goldberg said, referring to Bank of America’s stock performance this year. “They’ve played some catch-up.”

The stress tests by the Federal Reserve, the third and most stringent to be conducted since the financial crisis in 2008, examined how bank capital levels would be affected by a deep economic decline in the United States and a simultaneous shock in Europe. Banks were required to keep their Tier 1 capital ratio — the strictest measure of a bank’s ability to absorb financial blows — at 5 percent or more under the situation outlined by the Fed.

Both Bank of America and Citigroup passed the initial part of the test, but after taking into account Citigroup’s plan to return capital, its Tier 1 ratio fell to 4.9 percent.

Citigroup’s own executives were taken aback by the Fed decision. But as the focus shifts to earnings this week, Wall Street has been getting more optimistic about Citigroup.

On Thursday, Mr. Goldberg sharply increased his estimate for Citigroup’s quarterly earnings to $1.30 a share, from 97 cents a share, thanks to one-time asset sales as well as better-performing capital markets that could raise trading revenue. He kept his Bank of America estimate flat at 9 cents a share for the first quarter.

The first indication of how big banks performed in the first quarter will come Friday, when two of the stronger companies in the sector, JPMorgan Chase and Wells Fargo , announce their latest results. Citigroup reports on April 16, with Bank of America disclosing earnings on April 19.

Despite Citigroup’s negative stress test result and Bank of America’s better performance, some analysts remain cautious on Bank of America, which recently ceded its status as the largest bank in the country to JPMorgan Chase.

Chris Kotowski, an analyst at Oppenheimer, said, “The comparison of Citi and Bank of America is one of my favorite themes.” Both trade at about 70 percent of book value, and both have been steadily increasing their capital levels since the dark days of 2008. However, Mr. Kotowski favors Citigroup, largely because it does not face the mortgage-related headwinds Bank of America is dealing with.

Bank of America and the subprime giant it bought in 2008, Countrywide Financial, securitized and sold mortgages now worth $750 billion before the housing bubble burst. Of those mortgages, about $220 billion to $250 billion worth are delinquent or in foreclosure. Investors have lost about $125 billion, Mr. Kotowski said, and are trying to force Bank of America to buy back some of those securities, arguing the loans were made improperly.

Bank of America has already set aside $15 billion to cover potential losses on these so-called put-backs, but “who knows if that is enough?” Mr. Kotowski said. He added, “It could be, but there is no way to know.”

Citigroup faces potential put-back losses, too, but they are only a fraction of what Bank of America is contending with, he said.

For all the similarities between the banks, earnings in the future will be driven by different factors at the two giants, analysts said. Investors in Bank of America are hoping it benefits from a recovery in the United States economy over all, and the American housing market in particular. Bank of America draws 78 percent of its revenue from the United States.

For Citigroup, on the other hand, more is tied to how Wall Street performs, as well as the performance of international markets, where about half of Citigroup’s revenue comes from, especially in emerging areas like Asia and Latin America.

“Bank of America will get better if housing gets better,” said David H. Ellison, a mutual fund manager for FBR who invests in financial companies and owns stock in both companies. “Citigroup’s business is more commercial and will benefit if consumer credit improves.”

The bottom line, Mr. Ellison said, is that just three years after being written off by Wall Street, “both banks are going to survive and make money; the world isn’t coming to an end.”

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