Dick Bove's bold bank call
The banking bull says that the nation's biggest financial institutions are ready for a big bounce once the economy gets back on track.
NEW YORK (Fortune) -- If you missed the rally in bank stocks this year, longtime analyst Dick Bove says not to worry. He predicts that large banks' shares will double by the end of next year.
The KBW Bank Index (BKX), which tracks 24 of the country's lenders, is up 136% since March lows -- more than double the S&P 500's rise. Bove is betting the rally can continue.
His bullish call is based on large banks' huge loan-loss provisions and cash stockpiles. Citigroup, for example, now has $244 billion in cash, almost double what it had last fall. According to Bove, banks haven't held such a high percentage of capital to assets since 1936.
He says that when the outlook for the economy improves, the banks will have to reduce their loan-loss provisions -- which are deducted from what would be pretax earnings -- thereby adding to profits. He sees banks posting three more quarters of losses; after mid-2010 "you'll start to see a huge surge in earnings," says Bove.
Bove explains that this has happened before. For more than a decade starting in 1980, the nation's banks earned approximately $20 billion each year. After the market's collapse in 1987, however, banks were forced to dramatically increase capital.
Common equity and loan loss reserves dramatically rose, but when the 1991-92 recession hit, banks started using those excess reserves after being pushed the government to lend to consumers. Six years later, banks had increased profits more than four-fold to $90 billion.
"We're in exactly the same position," says Bove. "That was simply due to the use of excess capacity on the balance sheet.
Bove advises buying the following stocks:
- Citigroup (C, Fortune 500)
- Bank of America (BAC, Fortune 500)
- Goldman Sachs (GS, Fortune 500)
- J.P. Morgan Chase (JPM, Fortune 500)
- Morgan Stanley (MS, Fortune 500)
One notable exception is Wells Fargo (WFC, Fortune 500), whose stock he cut to a sell rating after concluding that its recent earnings weren't sustainable. He warns against buying regional banks, many of which don't have enough capital to survive a potential collapse in commercial real estate.
Bove has a mixed record on recent calls. He foresaw trouble at Lehman Brothers and told clients to sell its stock four months before the broker-dealer collapsed. But he also told investors to load up on financial companies in early 2008 after declaring that the financial crisis was over. "It was a horrible year," he admits.
Another well-known bank analyst, Mike Mayo of Calyon Securities, has a very different view. With the exception of Goldman, he rates most bank shares "underperform." He's the only Wall Street analyst, for instance, who recommends selling Bank of America shares.
Mayo expects bank stocks to decline as investors become scared by potential risks like rising unemployment, accelerating inflation, and still-falling home prices. He says that will cause investors to judge banks by their current book value instead of future earnings.