Dick Bove, the blunt-speaking analyst for Rochdale Securities, has an interesting take on the Moody's downgrade of bank stocks the other day. As I learned from a panel of distinguished mutual fund managers at Morningstar's Investment Conference last week, "Be fearful when others are greedy. Be greedy when others are fearful." By Bove's math U.S. banks are valued by some bad joo-joo and not actual fundamentals. He calls Moody's call an "absurdity," and says bank CEO's may have lied in 2007, but they are not now: fundamentally, banks are performing well.
Here are Dick Bove's remarks:
Bank Equities Are Not Dead
On August 13, 1979, the front cover of legacy Business Week published a story entitled the "Death of Equities." The S&P 500 was 107.40 that month. It has since risen to 1,335.02, or by a compounded annual growth rate of 8.1%. Two days ago Moody’s downgraded a number of American bank stocks despite the fact that these banks have meaningfully improved their ability to service their debt.
Was the Moody’s move as wrong-headed as the move by legacy Business Week? Will bank stocks crawl out of their holes as the S&P 500 did in 1979? There is no certain answer to the question, but the signs are getting more positive that bank stocks will continue their upward climb from where they stood in March 2009 (the S&P Bank Index is up 224% from that low).
Psychology vs. Fundamentals
The issues are selling at their present point due to psychology.
The fundamental metrics of the industry have changed meaningfully:
In March 2009, tangible common equity to assets was 7.13% for the industry. It was 8.69% in March of 2012.
Common equity plus reserves were 11.5% of assets; it is 12.7% now.
Deposits funded 66.2% of assets in March 2009; they fund 73.7% now.
Common equity plus deposits funded 76.3% of assets in March 2009, they fund 85.1% now (highest level in 18 years).
Net cash, as calculated by Rochdale Securities, was 6.15% of assets; it is 9.40% now.
Loans to deposits were 86.4% in March 2009; they are 72.2% now (lowest ratio since 1984 when the FDIC began publishing quarterly numbers).
Borrowed funds are down by $196 billion from March 2009 to March 2012.
Non-Performing assets (NPA) peaked in March of 2010 at $521 billion; they are $474 billion now.
Industry net income has been up 11 quarters in a row on a year-over-year basis.
In the first quarter of 2012, net income was up 22.8% year-over-year and 38.0% quarter-over-quarter.
The last time the industry earned $35.4 billion, which it earned in the first quarter of 2012, was the second quarter of 2007. These were peak earnings in 2007. Current earnings are well below the peak estimated for this cycle. The S&P Banking index closed the second quarter of 2012 at 386.81. It is 151.38 now. Thus, bank stock prices are down 60.9% from the second quarter of 2007 to the present on a 4.5% decline in quarterly earnings.
Clearly, equity investors have decided to ignore the fundamentals of this industry in pricing these stocks. Far more important is psychology. Bank CEOs lied about the strength of their companies in 2007 and the market has never forgiven them for that. Consequently, investors immediately reject any positive data about the industry. They immediately embrace the negatives.
This may be about to change. The absurdity of Moody’s arguing that banks are less able to meet the interest and principal payments on their debt today than was the case at any point in the past four years may have been an eye opener. The prices of bank debt are rising not falling indicating that the fixed income buyer has totally rejected the Moody’s notion. Bank funding costs are declining, not rising, and indicating that in the debt markets fundamentals count more than psychology.
The banks just won a big mortgage case in Massachusetts. Europe is reaching crisis stage whereby it may now be necessary for the banks and governments to pay the cost of solving the problems. Equity investors may be about to stop being driven by psychology and look at fundamentals again. If so, the bank stocks will double and the Moody’s downgrades will certify that this is the bottom.