It has been a rough few months for America's vaunted financial institutions, which are under siege. As the mortgage debacle has spread, banks and Wall Street investment houses have seen their stocks crash after they disclosed billions of dollars in losses, and the chief executives at Citigroup (C) and Merrill Lynch (MER) have stepped down. Many experts predict more pain ahead. On Nov. 19, analyst William Tanona of Goldman Sachs said that Citi may have to take writedowns totaling $15 billion over the next two quarters, while he also lowered his price targets on seven financial stocks. There may even be more CEOs who find themselves out on the street (BusinessWeek.com, 11/14/07).
But are there investment opportunities amid the wreckage? Some investors think so. They're diving right in and gobbling up shares of the financial houses at the center of the maelstrom, including Bank of America (BAC), Citigroup, American International Group (AIG), JPMorgan Chase (JPM), Merrill Lynch, and Morgan Stanley (MS). "We are buying them all," says David Katz, chief investment officer at Matrix Asset Management, a New York money management firm with assets of $1.6 billion.
Are Katz and other money managers playing with fire? There certainly are risks. But the rewards to confronting the risks look compelling, given the financial firms' steep fall. As of Nov. 19, Citigroup is down to $32.50 a share from its 52-week high of $57 on Dec. 28, 2006. Bank of America is at $43.15, down from $55.08 on Nov. 20, 2006. AIG is at $55, down from $72.97 on May 11. JPMorgan is at $42, off from its high of $53.25 on May 9. Merrill Lynch tumbled to $53.50, from $98.68 on Jan. 18. And Morgan Stanley dropped to $51.16 from $75.50 on June 15.
The Case for Buying
The argument for buying is not that these companies won't have more problems. Perhaps some of them will. But Katz and others believe that, as a group, these giant finance companies play such a central role in the economy that they'll continue to have bright prospects. "We aren't playing with fire, because these companies are the biggest and the best players in finance and investments, with tremendous, diverse resources and clean balance sheets," says Katz.
These stocks are now priced as if there has been a permanent impairment in their earnings power. While the subprime problem is still a major concern, Katz is convinced many of the financial institutions are getting closer to cleaning up the mess. "They have the financial wherewithal to exit this period with strong balance sheets and prospering businesses," says Katz. Their stocks are selling at the low end of their 6- and 10-year valuation ranges in terms of their price-earnings and price-to-book ratios.
Be Discriminating
To be sure, there are still plenty of financial stocks that don't look like bargains, despite their battered stock prices. Those closest to the mortgage mess appear to have the most risk, if the housing downturn continues. "We are wary of companies whose main businesses are in the subprime market or mortgage lending, and whose exposure to mortgage loans constitutes their main source of income," says one New York investment manager who, otherwise, has been buying diversified financial-services companies.
Among the stocks to avoid: Washington Mutual (WM), the largest U.S. savings and loan association, which Standard & Poor's rates a sell; Countrywide Financial (CFC), which originates, buys, securitizes, and sells service mortgages; and Ambac Financial Group (ABK), the second-largest municipal bond insurer. Also unattractive because of the risk and uncertainty surrounding them are investment bank Bear Stearns (BSC) and the Federal National Mortgage Assn. (FNM), known as Fannie Mae, a government-sponsored enterprise that buys mortgage assets from other lenders.