The last of the big Wall Street banks' efforts to repay TARP funds met with mixed results in the stock market last week — a cautionary tale for investors who are looking to dabble in the financial services sector.
Wells Fargo & Co.'s stock (WFC) went up after it said last Monday that it was repaying the government, and continued to rise the next day after it sold $12.25 billion in a stock offering.
Citigroup Inc.'s stock (C), however, took a hit following its Monday repayment announcement and continued to slide after it sold $17 billion in stock for a price so low that the Treasury Department delayed plans to sell its stake in the company.
“It's a stock picker's market,” said Peter Kovalski, manager of the $7.7 million Alpine Dynamic Financial Services Fund (ADFSX), from Alpine Woods Capital Investors LLC.
Heading into 2010, there's great potential in beaten-down financial stocks, but pick the wrong stocks and it could be disastrous, he said.
That's particularly true of the large Wall Street banks.
“They still aren't out of the woods yet,” Mr. Kovalski said.
“In most cases, they don't have the excess capital needed if there's a double-dip recession. They could be in a position where they have to come back and raise additional capital,” Mr. Kovalski said.
And as Citigroup's disappointing stock sale shows, that could be difficult.
Large banks still have a ways to go before they resolve all of their problems, said Frederick Cannon, co-head of research and chief equity strategist at financial services investment-banking specialist Keefe Bruyette & Woods Inc.
“We think we're another year or so away from normal returns in the banking industry,” he said. “There will be significant credit losses absorbed in 2010.”
ON THE REBOUND
That said, things are improving.
Large institutions such as Wells Fargo, JPMorgan Chase & Co. (JPM) and Bank of America Corp. (BAC) have grown during the recession, strengthened their balance sheets and removed themselves from government support, Mr. Cannon said.
That's why KBW is recommending all of the trillion-dollar-asset institutions that have emerged from the crisis and have repaid, or have announced plans to repay, funds received through the Troubled Asset Relief Program.
Douglas Burtnick, co-manager of the $46.2 million Aberdeen Global Financial Services Fund (GLFAX), from Aberdeen Asset Management Inc., isn't ready to invest in all the large Wall Street banks, but he does see value in a few names.
JPMorgan and The Goldman Sachs Group Inc. (GS) “are very well-positioned to take share relative to their peers,” he said.
Indeed, Standard & Poor's on Friday upgraded Goldman to “strong buy,” from “buy.”
Citigroup and Bank of America, however, are less attractive, said Stuart Quint, co-manager of the Aberdeen fund.
Citigroup will have to contend with “reduced revenue streams,” and BofA is still coming to grips with its “complicated integration” of Merrill Lynch & Co. Inc., he said.
Just last Wednesday, Bank of America promoted Brian T. Moynihan to chief executive, replacing Kenneth D. Lewis, who was pushed into retirement.
Of course, the financial services sector is more than just big banks.
There's a “consolidation tidal wave” occurring at the regional-bank level, said Anton Schutz, manager of the $52.5 million Burnham Financial Services Fund (BURKX) and $118.6 million Burnham Financial Industries Fund (BURFX), from Burnham Financial Group.
Healthy regional banks stand to benefit from purchasing “sick banks,” said Mr. Schutz, president and chief investment officer of Mendon Capital Advisors Corp., subadviser to the two Burnham funds.
That could benefit investors who bet on the right regional bank, he said.
For example, when it was an-nounced Dec. 11 that 1st United Bancorp Inc. (FUBC) had assumed all of the deposits of Republic Federal Bank NA, “that stock popped nicely,” Mr. Schutz said.
It closed at $6.73 a share the day the announcement was made, and opened at $7.90 the next day.
Investing in regional banks makes sense, as they tend to benefit most from acquisitions, Mr. Kovalski said. A deal can mean more to their “bottom lines” than it would to the trillion-dollar-asset institutions'.
But Mr. Kovalski said the area of financial services with the most potential for stock appreciation isn't banking; it's asset management.
“I would expect that as the market recovers, the group should be well-positioned to benefit,” Mr. Kovalski said.
A LEGG UP
Legg Mason Inc. (LM) looks particularly interesting, he said.
For the most part, it has worked though its problems — bets on highly levered investment vehicles that went disastrously wrong — and is now in a good position to gain assets, Mr. Kovalski said.
Exchange operators also look attractive heading into 2010, he said.
In particular, he likes CME Group Inc. (CME) and IntercontinentalExchange Inc. (ICE), both of which specialize in derivatives.
They are attractive because they are essentially a “play on the growth of commodities,” Mr. Kovalski said.
That may be true, but financial advisers remain leery of financial services.
The state of the large Wall Street banks worries them most.
“It's hard to get conviction about what's really on their balance sheets,” said J. Michael Martin, president of Financial Advantage Inc., an investment advisory firm with $250 million in assets under management.
Putting the banks aside, Paul Schatz, president and chief investment officer of Heritage Capital LLC, expects that the sector probably will do well, but he does not intend to focus on it.
“I think you will make money in financial services, but I do not think it will be a leadership sector,” said Mr. Schatz, whose firm advises on about $130 million in assets.
E-mail David Hoffman at [email protected].
