Before You Buy Bank of America: Here's a Banking Stock I'd Buy First

It's a familiar enough name. Bank of America (BAC -0.21%) is one of the United States' biggest banks (as measured by total assets), and it's the third biggest as measured by total branches. You could certainly do worse than owning BofA stock.

You could arguably do better too, however, at least right now. Smaller U.S. Bancorp (USB 0.32%) is a much better bet at this point in time. Here's why.

3 reasons U.S. Bancorp is just better

If you already own a stake in BofA, you're hardly doomed. It's going to be fine. There's no need to sell it, particularly if doing so creates an unwanted tax bill.

If you've yet to fill in your portfolio's financial sector gaps, though, there are three key reasons you may want to choose U.S. Bancorp instead. Let's go from least important to most important.

1. U.S. Bancorp generally has better banking metrics

It's too easy to fall into the trap of comparing two or more banks by comparing their critical banking metrics, like returns on tangible common equity (ROTCE) or common equity tier 1 capital ratio (CET1). These are important, but there's always more to the story. On the flip side, these numbers can tell you a great deal about how well a bank's assets are being managed.

With that as the backdrop, note that U.S. Bancorp is outshining bigger BofA in a handful of key ways. Last quarter's ROTCE of 22%, for instance, is better than BofA's 17.4%, while BofA's first-quarter efficiency ratio of 61.8% is below U.S. Bank's 63.2%. U.S. Bancorp's Q1 net charge-off ratio of only 0.39% is also lower than BofA's 0.58%.

By banking standards, those are pretty wide disparities.

It's just one quarter, to be fair, and BofA is doing better with some other metrics, such as the CET1. Overall, though, U.S. Bank boasts the better report card right now. It could be a function of size; smaller banks are simply easier to manage than bigger ones.

2. U.S. Bancorp has a better balance sheet

The Silicon Valley Bank and First Republic debacles may be in the rearview mirror, but their underpinnings are still with us -- some banks more so than others.

As a refresher, the big misstep at SVB Financial's (SIVB.Q) Silicon Valley Bank was investing too much capital in so-called held-to-maturity bonds, and not enough in available-for-sale debt. The former tends to pay better interest rates because they're longer-dated bonds. But rising interest rates take a bigger toll on their market values. The latter, as the name suggests, can be sold immediately to cover bank customers' withdrawals, yet they don't yield much in the meantime. Silicon Valley Bank was forced to sell the bulk of its available-for-sale securities in March, yet it still wasn't enough to fully fund all of its liabilities.

Great, but what's that got to do with BofA or U.S. Bancorp? Well, everything. All banks use their capital to purchase long-term, held-to-maturity securities as well as shorter-term, available-for-sale bonds. It's just a question of how much of each.

To this end, as of the end of Q1, BofA is holding $162 billion worth of available-for-sale debt and $525 billion in far less liquid held-to-maturity securities. U.S. Bank has a much better balance, with $65.5 billion worth of available-for-sale debt on its books, and $88.5 billion in held-to-maturity bonds.

Don't freak out. BofA is hardly insolvent. Its assets are less than ideally balanced in light of the current environment, though. That could stymie fiscal flexibility into the foreseeable future.

U.S. Bancorp isn't facing the same prospective limitation.

3. U.S. Bancorp has a bigger dividend yield

Last but not least, step into U.S. Bank rather than BofA if you care about dividends, because U.S. Bank offers the better dividend right now. It's yielding 5.9%, while BofA stock is paying out only 3% of its current value.

Yields aren't everything, of course. There's also the not-so-small matter of how much a dividend has increased in the past, and how likely it is to grow in the future. Has the bank in question paid its dividend reliably? Can it even afford to keep paying it?

U.S. Bancorp's dividend pedigree is solid enough by all of those measures, too. Not only has the bank paid a dividend every quarter since 1999, but it has also raised its payout every year since 2010. The current quarterly payment of $0.48 per share is also only about half of its typical quarterly per-share earnings right now.

Choose U.S. Bank over BofA until the backdrop improves

U.S. Bank's edge on BofA won't last forever. That is to say, there will come a time when BofA stock is the better bet. Bigger banks seem to fare better in robust economic environments that drive bull markets. That's when a bank of BofA's stature can use its size to bully smaller banks.

The current lethargic environment, however, favors the smaller, nimbler banks that don't have much of an opportunity to get into difficult situations in the first place. It would also be short-sighted to not point out that U.S. Bancorp shares aren't bouncing back quite as well from March's setback as BofA's stock is. Go figure.

Regardless, if you were mulling a new position in BofA, you may be better off with U.S. Bank instead.