As the Federal Reserve conducts its two-part stress test over the next week, veteran bank analyst Richard Bove continues to be bullish on the banking sector and sees bank stocks going "substantially higher" when the tests conclude.
Bove expects that across the board banks will raise dividends and said that this type of action is exactly what investors want to see.
"Quite frankly, the banking industry across the board is doing extraordinarily well," Bove told CNBC's "Squawk on the Street" Thursday. "If you look at some of the core statistics, for 14 quarters bank earnings have been up year-over-year in every quarter. In 2012, the industry had a 19 percent increase in earnings and it was the second best year in the banking industry in the United States."
"In the first quarter of 2013, the banking industry will make more money than in any quarter in the history of American banking," he said. "You have so much excess capital in the banking industry at the present time that you have to go back to 1938 to find a year in which the percentage of capital to assets was as high as it is now."
Late on Thursday, the Federal Reserve is expected to reveal how much capital 18 large banks would maintain under a hypothetical severe economic downturn.A week later, the agency plans to disclose how the banks would have fared if they had first spent some of their capital buying back shares or paying higher dividends.
Investors in U.S. bank stocks are expecting volatility in the interim as the process is spread out. Last year, the Fed disclosed all of the information on the same day.
Bove is focused on the second half of the stress tests next Thursday, which he said will reveal the names that will pay the larger relative increases in dividends.
"They're all going to show increases in dividends and the percentage increases could be very big in some cases," he said, although in some names, like Bank of America, even a 50 percent increase in the dividend would be "meaningless" because the resulting dividend would still be relatively low, he added.
"What you're looking for in names like Citigroup and Bank of America is some increase in dividends to certify that the Federal Reserve is not unhappy with them," he said. Bove pointed to regional names such as US Bancorp that have a potential for a meaningful increase in dividends as well as Wells Fargo, which Bove thinks could also have a "nice increase" in dividends after the stress tests.
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