Why Citi is the Big-Bank Winner Today as Bank of America Loses Out

Alex Dumortier, CFA, The Motley Fool
Updated

Buoyed by positive employment data for the month of February released this morning, stocks opened significantly higher this morning, and the Dow Jones Industrial Average (INDEX: ^DJI) looked poised to set yet another nominal closing high. However, the S&P 500 and the narrower, price-weighted Dow have since fallen back to just above breakeven, up 0.1% and 0.15%, respectively, as of 10:05 a.m. EST.

Banks are OK
The results of the Fed's third annual round of bank stress tests are in and -- drum roll -- banks passed! (All but Ally Financial, that is.) Were you expecting anything different? Here's how the stress test works: The Fed comes up with a hellfire ("severely adverse") scenario for the economy, and financial markets and banks tot up their expected losses and their capital position under that scenario. The object is to verify whether bank balance sheets can withstand a brutal macroeconomic shock, which, in this case, included:

  • A peak unemployment rate of 12.1% -- roughly 50% higher than it is today and 1.4 percentage points higher than the highest rate achieved since 1948.

  • A greater-than-50% decline in stock prices.

  • A 20% decline in housing prices.

Note that the two remaining pure-play investment banks, Morgan Stanley and Goldman Sachs , came in with the lowest stress-scenario capital ratios, barely above the aggregate Tier 1 common equity ratio of 5.6% for the 18 firms at the end of 2008 -- just prior to the first round of stress tests in early 2009, which prompted massive raises. The minimum required ratio is 5%. Goldman's forecast losses under the stress test scenario are $20 billion, above analyst expectations. These results are putting pressure on investment bank shares.


Meanwhile, with respective stress-scenario Tier 1 common equity ratios of 6.8% and 8.3%, Bank of America and Citigroup look in a more comfortable position. For shareholders, that means the prospect of return of capital via dividend increases or share repurchases. Indeed, Citi announced a $1.2 billion buyback over the next 12 months -- its biggest return of capital since 2006 -- giving the shares a healthy boost this morning. Investors are cheering the news, boosting Citi shares by 1.2%. No word from B of A, whose shares, down 1.6%, are paying the price for this silence.

Bank of America's stock doubled in 2012. Is there more yet to come? With significant challenges still ahead, it's critical to have a solid understanding of this megabank before adding it to your portfolio. In The Motley Fool's premium research report on B of A, analyst Anand Chokkavelu, CFA, and Financials bureau chief Matt Koppenheffer lift the veil on the bank's operations, including three reasons to buy and three reasons to sell. Click here now to claim your copy.

The article Why Citi is the Big-Bank Winner Today as Bank of America Loses Out originally appeared on Fool.com.

Fool contributor Alex Dumortier, CFA has no position in any stocks mentioned; you can follow him on LinkedIn. The Motley Fool recommends Goldman Sachs. The Motley Fool owns shares of Bank of America and Citigroup Inc. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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