The banking industry has been under pressure lately due to major credit rating agencies' rating cuts (or warnings). Higher borrowing costs, large deposit outflows, and elevated interest rates are some factors that threaten the strength of the sector’s overall health.

In this piece, I have compared Bank of America Corporation (BAC) and Citigroup Inc. (C) to determine a better investment.

Earlier this year, the U.S. banking industry was shaken by the collapse of Silicon Valley Bank, Signature Bank, and First Republic Bank in quick succession. Banks continued to lose deposits during the second quarter. America’s largest banks by assets, including BAC and C, lost $262 billion in deposits compared to the prior-year period.

When the banks were recovering from the crisis, major credit rating agencies started revisiting the ratings of banks for potential downgrades on their financial health concerns.

Fitch had downgraded the entire U.S. banking sector in June and has recently warned of potential rating downgrade of the biggest banks. In the meantime, Moody’s downgraded 10 banks and put six others on notice. The S&P Global followed suit and downgraded five U.S. banks while putting two others on notice.

The downgrades are primarily due to the benchmark interest rates, which are at their highest level in 22 years. The high-interest rates have increased the deposit costs for banks. Moreover, higher interest rates and stricter lending standards make it difficult for borrowers to get loans.

The rating downgrades would mean higher borrowing costs and even tougher lending standards. Moreover, losses arising from commercial real estate loans will likely be a headwind for the banking sector.

Despite the challenges, big banks like BAC comfortably surpassed the revenue and earnings estimates in the second quarter. BAC’s EPS came in 4.9% higher than the consensus estimate, while its revenue beat the analyst estimates by 1%. Similarly, C’s revenue was 0.8% above the Street estimate. However, its EPS fell short of the consensus estimate by 0.9%.

Commenting on their second quarter performance, BAC’s CFO Alastair Borthwick said, “Asset quality and the overall health of the U.S. consumer remained strong. Total loss rates remained below pre-pandemic levels. Our balance sheet remained strong with $190 billion of regulatory capital and a CET1 ratio nearly 120 basis points above our current minimum requirements.”

C’s CEO Jane Fraser said, “We remain laser-focused on executing our strategy while continuing to simplify and modernize our bank. We are on track with the plan we laid out at Investor Day and remain committed to reaching our medium-term return targets. We ended the second quarter with a CET1 ratio of 13.3%, which was 100 basis points above our new regulatory requirement that goes into effect in the fourth quarter.”

There is little to differentiate between the two stocks regarding price performance. Both stocks have delivered negative returns across different time frames. BAC’s stock has declined 11% over the past month, while C’s stock has fallen 12.7% during the same time frame. Similarly, BAC’s stock has declined 24.4% over the past nine months, while C has fallen 9.2% in the same time period.

Let’s take a look at the factors that could help determine the better investment:

Recent Financial Results

For the second quarter ended June 30, 2023, BAC’s total revenue, net of interest expense, increased 11.1% year-over-year to $25.20 billion. Its net income applicable to common stockholders rose 19.7% year-over-year to $7.10 billion.

Additionally, its EPS came in at $0.88, representing an increase of 20.5% year-over-year. Also, its net interest income rose 13.8% over the prior-year quarter to $14.16 billion. In addition, its CET1 ratio came in at 11.6%, compared to 10.5% in the year-ago quarter.

C’s total revenues, net of interest expense, for the second quarter ended June 30, 2023, declined 1% year-over-year to $19.44 billion. Its net income declined 35.9% year-over-year to $2.92 billion. Also, its EPS came in at $1.33, representing a decline of 39% year-over-year.

On the other hand, its book value per share rose 5% year-over-year to $97.87. In addition, its CET1 ratio came in at 13.3%, compared to 12% in the year-ago quarter.

Expected Financial Performance

Analysts expect BAC’s EPS and revenue for fiscal 2023 to increase 6.2% and 6.3% year-over-year to $3.39 and $100.93 billion, respectively. On the other hand, its EPS and revenue for fiscal 2024 are expected to decline 3.3% and 0.6% year-over-year to $3.28 and $100.33 billion, respectively.

For fiscal 2023, C’s EPS is expected to decline 18.6% year-over-year to $5.78. On the other hand, its EPS for fiscal 2024 is expected to increase 7.8% year-over-year to $6.23. Its revenue for fiscal 2023 and 2024 is expected to increase 4.9% and 0.6% year-over-year to $79.05 billion and $79.52 billion.

Profitability

BAC’s trailing-12-month revenue is 1.36 times what C generates. BAC is more profitable, with a net income margin and Return on Equity of 30.88% and 10.78%, compared to C’s 19.09% and 6.68%, respectively. Also, BAC’s Return on Assets of 1.39% compares to C’s 1.30%.

Valuation

In terms of trailing-12-month Price/Book, BAC is currently trading at 0.89x, 111.9% higher than C’s 0.42x. BAC’s trailing-12-month Price/Sales ratio of 2.38x is 110.6% higher than C’s 1.13x.

Thus, C is relatively more affordable.

POWR Ratings

BAC and C have an overall rating of C, equating to a Neutral in our proprietary POWR Ratings system. The POWR Ratings are calculated considering 118 different factors, with each factor weighted to an optimal degree.

Our proprietary rating system also evaluates each stock based on eight distinct categories. BAC and C have a C grade for Quality, in sync with their mixed profitability.

BAC and C have a B grade for Value, consistent with their discounted valuation.

Of the 10 stocks in the Money Center Banks industry, BAC is ranked first, while C is ranked #3 in the same industry.

Beyond what we’ve stated above, we have also rated both stocks for Growth, Momentum, Stability, and Sentiment. Click here to view BAC ratings. Get all the ratings of C here.

The Winner

The Fed minutes show that most policymakers prioritized the battle against inflation by opting for more interest rate hikes. More interest rate hikes could benefit banks as it helps them increase their net interest income.

However, credit rating agencies' downgrades of several banks will likely be a stumbling block for the banking sector in the near term. The downgrades are likely to increase banks’ cost of capital and raise borrowing costs. Moreover, stricter lending standards will hamper bank’s ability to lend.

Amid this uncertainty prevailing in the banking sector, waiting for a better entry point in both stocks could be wise.

Our research shows that the odds of success increase when one invests in stocks with an Overall Rating of Strong Buy or Buy. While there are currently limited investment options in the banking sector, check all the top-rated stocks in the Consumer Financial Services industry here.

What To Do Next?

Discover 10 widely held stocks that our proprietary model shows have tremendous downside potential. Please make sure none of these “death trap” stocks are lurking in your portfolio:

10 Stocks to SELL NOW! >

BAC shares were trading at $28.63 per share on Thursday morning, up $0.18 (+0.63%). Year-to-date, BAC has declined -12.30%, versus a 16.04% rise in the benchmark S&P 500 index during the same period.

Since he was in grade school, Dipanjan was interested in the stock market. This led to him obtaining a master’s degree in Finance and Accounting. Currently, as an investment analyst and financial journalist, Dipanjan has a strong interest in reading and analyzing emerging trends in financial markets.

More...