FBR's Ellison "wants to own banks now," cuts cash

NEW YORK (Reuters) - It was the voice of legendary investor Peter Lynch urging David Ellison, a well-known manager of bank stocks, that led him to take his 60 percent hoard of cash and dive back into the battered financial sector in February.

Banks were trading at 10 percent of book value, a low that Ellison, chief investment officer at Boston-based FBR Funds, had not seen since the savings and loan and Latin American debt crises of the early 1990s ravaged banks.

For Ellison, who toiled under Lynch’s tutelage 25 years ago at Fidelity Investments, the plunge in financials earlier this year and jump in home sales in Phoenix and Las Vegas, which were hard hit by the housing slump, signaled it was time to buy.

“I just remember the echo of Peter saying, ‘Well look, if all these are at 10 percent of book and if the market is right that all these stocks are going to fail, it doesn’t matter, you might as well just buy ‘em because if they all go to zero, you’re not going to have a job anyway,’” Ellison told Reuters.

Ellison employs a “bottom-up” investment style that looks at companies from the ground up and that was epitomized by Lynch, who as manager of Fidelity’s Magellan fund racked up stellar returns. A $10,000 investment in Magellan during Lynch’s reign from 1977 to 1990 would have grown to $288,000.

Ellison, who in an interview on Thursday said that it would take “an awful lot of surprise bad news” for stocks to drop to their lows in March, manages both the small-cap and large-cap financial funds at FBR where he oversees about $1 billion.

“I think we’ve seen the highs on the stocks for awhile,” he said, “and I think you’ve seen the lows.”

Unlike other well-known investors, Ellison has avoided most of the blood bath in financials after the blow-up of two Bear Stearns hedge funds in the summer of 2007 marked the end of the U.S. housing bubble and the start of the credit crisis.

Ellison held about 10 percent cash in the FBR Large-Cap Financial FBRFX.O fund in early 2007, but he raised that position to more than 30 percent by that year's fall and to 50 percent as of January 31, 2009, according to regulatory filings.

Starting in February, with his cash position at about 60 percent, Ellison began buying bank stocks when the key KBW banking index .BKX lost more than half its value. Cash is now in the 10 percent range.

“I bought them on the way down, I didn’t pick the bottom,” he said. “I really started to get more aggressive as I started to see home price activity pick up in some of these markets where you had an 80 percent increase in home sales.”

With the government’s financial backing and management’s efforts to clean up their operations, banks have the wind behind them and are a good investment, Ellison said. The worst of the financial crisis is over, he said.

Banks are reducing costs, improving lending standards and making their balance sheets far easier to understand, which means in less than seven years -- the average life of a bank’s loan portfolio -- they should be in good shape, he said.

With the exception of Citigroup Inc C.N, the leadership in the top U.S. banks, including Bank of America Corp BAC.N, is much better than it was in 1990, he said.

“I want to own them now, and I want to sell them in seven years when it’s all cleaned out,” he said.

“You go from ugly to OK to good to great and the last time they were ugly was 1990-1991, and from ‘91 to ‘95 was the best time to buy bank stocks in my career.”

Ellison said "safe" bets in the banking sector include JPMorgan Chase JPM.N, Wells Fargo & Co WFC.N and PNC Financial Services Group Inc PNC.N. Banks that need to raise capital but also represent good value include SunTrust Banks Inc STI.N, KeyCorp KEY.N, Fifth Third Bancorp FITB.O and Comerica Inc CMA.N.

As of Thursday, over the past 12 months Ellison's large cap fund is down 19.4 percent, compared to a 53.2 percent drop in the Standard & Poor's 500 Financial Index .GSPF.

Reporting by Herbert Lash; Editing by Kenneth Barry