It's been quite a financial turnaround. Less than a decade ago, many big U.S. banks were on the verge of collapse during the financial crisis. Today, the banking sector appears to be in robust health. Indeed, respected bank analyst Dick Bove of the Vertical Group goes so far as to assert that banks are entering an unprecedented period of growth, what he calls "a true 'Nirvana' here on earth," in a commentary for CNBC. He rests his optimism on four factors: tax reform, a shift in monetary policy, regulatory reform, and technological advances.
While a growing number of analysts and strategists are presenting optimistic outlooks for the U.S. banking sector over the next year or so, Bove goes far beyond that with his belief that banks are entering a golden era that should last many years into the future. His upbeat view also contrasts sharply with gloomy observations by the U.S. Treasury Department and Harvard economist Kenneth Rogoff, among others, that risks in the banking system remain high, and that a new banking crisis is possible. (For more, see also: Banks Have No Plan For New Financial Crisis: Harvard's Rogoff.)
Share Price Rebound
The widely-followed KBW Nasdaq Bank Index (BKX) bottomed out at a value of 19.58 in midday trading on February 20, 2009, per Yahoo Finance. Its closing value of 116.15 on January 24 represents an astonishing rebound of 493%. The share prices of the six biggest U.S. banking institutions have enjoyed similarly spectacular recoveries over this period: Bank of America Corp. (BAC), +1,168%; Citigroup Inc. (C), +393%; JPMorgan Chase & Co. (JPM), +517%; Wells Fargo & Co. (WFC), +643%; Morgan Stanley (MS), +216%; and Goldman Sachs Group Inc. (GS), +251%.
Bove says tax cuts will have a major impact on the banks. Prior to tax reform, the average bank in the U.S. faced a tax rate of 30% to 31%, Bove says, and the new law will reduce this burden by about 8 to 12 percentage points, depending on the institution. Additionally, certain tax deductions remain in place for the banks, meaning that some of the biggest institutions now will have effective tax rates in the range of 18% to 19%.
If the tax bill also succeeds in stimulating the economy, Bove notes that the demand for loans will increase, providing another impetus to bank profits. Last, banks took a number of charges related to tax reform in the fourth quarter of 2017. "Losses were pulled forward so the slate should be cleaned for 2018," as he puts it.
Monetary Policy Shift
The banks will benefit from longterm trends in monetary policy. "True interest rate movements last for 25 to 30 years," Bove says, citing historical data. If the Federal Reserve does shrink its balance sheet, and if global economic growth is sustained, Bove believes that we could see rising rates until the early 2040s. Rising rates generally lead to increased bank profits. The 1970s, when rates set historic peacetime highs, were an especially good period for bank earnings, Bove notes.
Bove lists nine key federal agencies that regulate banks, and notes that the leadership of eight has changed in the past year, in some cases with a "total revamping" of their boards. To his knowledge, such turnover has not happened since the 1930s, when many of these agencies were created. "The new teams are committed to easing and adjusting a number of the old team's regulations," he says. This will create "a series of big benefits" for banks, and may "ease virtually all requirements for smaller banks," he adds.
In addition to the three reasons cited above, the fourth driver of banks' growth is their technological leadership, Bove asserts, a fact that is not generally recognized. Few realize that Bank of America, for example, holds 43 patents for blockchain technology, the most of any company. Banks send vast amounts of data across the globe at lightning speed "with error rates that are virtually zero," he notes. This allows their customers to withdraw money wherever they may be on the planet in mere seconds. Banks also are leaders in the use of artificial intelligence (AI), in areas such as evaluating loan applications. As a result of their focus on developing and implementing advanced technology, banks are lowering their cost of doing business, Bove indicates, another reason for longterm optimism about the sector.
To Bove, these forces add up to one conclusion about the banks. "They are about to do very well for a long, long time. The only impediment that could derail this outlook is an economic recession and this does not look likely at the present time," he said per CNBC.