Tracking the Money Stocks

Even allowing for their post-September 11 drop, financial-services outfits have a lot going for them, according to a trio of S&P analysts

Stocks in the financial-services area -- banks, brokerages, and insurance companies -- have held up better than might have been expected since the terrorist attacks on New York and Washington. In agreement on that are three Standard & Poor's analysts: Catherine Seifert on insurance, Stephen Biggar on banking, and Robert McMillan on brokerages.

Seifert says the stocks, especially insurance issues, fell off a bit in the immediate aftermath but have come back a bit -- and, so far this year, have done slightly better than the broader market. Her favorites in the insurance group, however, are two stocks that might be exempt from much of the impact: Marsh & McLennan, which, as an insurance broker, doesn't have to pay claims but can benefit from increased premiums, and Allstate, with its extensive personal-lines coverage.

In banking, Biggar for the most part recommends mid-cap regional banks, because they have less exposure to international economies and the weak capital markets. But he has a buy on the merged J.P. Morgan Chase.

McMillan especially likes Lehman among the brokerages, partly because its fixed-income business is a cushion against downturns elsewhere. He's also high on Goldman Sachs and Morgan Stanley.

The analysts were guests in a chat presented Oct. 2 by BW Online and Standard & Poor's on AOL. Their comments were in response to questions from the audience and from Jack Dierdorff of BW Online. A full transcript is available from BW Online on AOL at keyword: BW Talk. Edited excerpts follow.

Q: How have the financial and insurance stocks been doing in general, and particularly since September 11?

A: (Cathy)

Before September 11, the stocks were down along with the market. Immediately after the attack, we saw a sell-off, particularly in insurance issues. However, in the last week or so, the entire sector has come back a bit, and so far this year, the financial-services sector is slightly outperforming the broader market.

Q: Are mid-cap banks the way to go for now?

A: (Steve)

We're generally favorable on mid-cap regional banks. The lower-interest-rate environment will help margins, although a sluggish economy will lead to subdued loan growth and some additional deterioration in credit quality. However, these banks tend not to have activities outside traditional lending, many of which have faced pressure because of weak capital-market activities and the downturn in international economies.

Q: Can you give us any banking names S&P ranks buy or accumulate?

A: (Steve)

Sure. We currently have buy recommendations on FleetBoston Financial (FBF ), IndyMac Bancorp (NDE ), J.P. Morgan Chase (JPM ), PNC Financial (PNC ), and Wilmington Trust (WL ). We have accumulates on BB&T (BBT ) and SouthTrust (SOTR ).

Q: Are the brokerage stocks a place to be now, or to avoid, with the market so uncertain?

A: (Bob)

Right now we are somewhat positive on brokerage stocks. They have come down about 45% since the beginning of the year. Over the next 12 months we expect that falling interest rates will stimulate the economy and lead to a rebound in corporate profits and higher equity prices, which is a positive for the brokers.

Top pick within the sector is Lehman Brothers (LEH ). We like the stock because it has a diversified and global business, and its fixed-income business helps offset weakness in the equity side of the business. The stock also trades at a discount to its price-book and price-earnings [ratios] compared to its larger peers. Other brokerage stocks we like are Morgan Stanley (MWD ) and Goldman Sachs (GS ).

Q: What's your view of brokerage giants such as Merrill Lynch (MER ) and Schwab (SCH )?

A: (Bob)

Right now we think that MER and SCH are fairly valued, but we think in the short term their business will be affected by the falling stock market, which will hurt commission revenue as well as their asset-management businesses. They have a 3-STARS [hold] ranking [in S&P's Stock Appreciation Ranking System].

Q: This would seem a somewhat contrarian time to invest in insurance companies -- what are you suggesting it?

A: (Cathy)

In the aftermath of the September 11 terrorist attacks, we anticipate insured losses will probably total in excess of $30 billion. As a result of these losses, insurance premiums, particularly commercial premiums, will rise sharply. However, the uncertainty surrounding the actual loss estimates, coupled with likely litigation, tempers our outlook here.

We recommend investors buy shares of those companies that will benefit from firmer premium rates but that do not have significant direct exposure to the World Trade Center. Our top picks are Allstate (ALL ) and Marsh & McLennan (MMC ).

Q: Cathy, when you name your favorites, is there a type of insurer that will fare best? Life vs. property, for example?


Actually, my reason for picking Marsh & McLennan as a 5-STAR [buy] is it's an insurance broker. As an insurance broker, it will benefit from higher premium rates, but as an intermediary vs. an underwriter they will not have to pay claims.

I like Allstate because as a leading personal-lines insurance carrier they will not likely have a significant number of claims from the September 11 terrorist attack but will also benefit from higher premium rates. Also, as a personal-lines insurance carrier, Allstate is somewhat recession-resistant.

Q: Steve, you've already named a few banks you like. In general, are the regionals a better buy now than the big money-center banks?


Yes. We believe that money-center banks will continue to face an environment of weak equity markets and their impact on capital-markets businesses -- as well as exposure to international economies, which are also expected to be weaker.

Q: With those weak equity markets Steve points out, Bob, I wonder if there are any names in your area that could be in trouble?


Well, right now we don't have any outright sells. We have two stocks -- E*Trade (ET ) and Schwab -- that are both 3-STARS [hold]. Both are heavily dependent on retail investment trading. As long as investor sentiment remains pessimistic, both companies will be adversely affected. In addition, both companies -- particularly E*Trade -- sell at significantly higher multiples than their more diversified larger peers.

Q: Do you think life insurance premiums will increase following the terrorist attacks?

A: (Cathy)

The quick answer is no. The underwriting factors that affect life insurance premiums are different than those that impact property insurance premiums. Competition will also prevent life insurance premiums from rising significantly.

Q: Lower corporate earnings are a widespread worry -- how bad does it look in the areas you cover?

A: (Cathy)

Lower equity values and lower interest rates, which will hurt investment income growth, coupled with claims from the September 11 terrorist attack, point to a very difficult 2001 for many insurers.

(Steve) Bank earnings estimates have been trending downward all this year, largely because economic growth has been weaker than expected and credit quality has been worse than expected. I also think that comparisons in the second half of 2001 will not improve, given the extended weak period of economic growth or negative growth in the second half.

Q: What is your outlook for Charter One Financial (CF )?

A: (Steve)

Just recently we began taking a more cautious view on thrifts and downgraded Charter One to hold. The shares have been relatively strong this year and have outperformed the broader market. We felt that with consumer confidence shaken and unemployment up, the risks outweighed the rewards for this normally defensive stock.

Q: What are the prospects for Citigroup (C ) and Household (HI ) through 2001?

A: (Steve)

We currently have a "hold" on Citigroup. I believe they will face some pressure from the slowdown in international economies. Citi was one of the first to quantify the impact of the World Trade Center attacks on their financial performance, and it was not substantial. They are also not likely to get much additional benefit from the expected lower interest-rate environment.

(Bob) We currently rate Household International 4-STAR [accumulate]. We think [in the] short term there will be difficulties as consumer confidence and spending decline following the terrorist attacks. But we think lower interest rates will help offset the impact of that, as well as credit quality. Going into 2002, we think that at some point lower rates will stimulate the economy, which will stimulate consumer confidence and spending.

Q: Any opinion on Wachovia (WB )?

A: (Steve)

We rank Wachovia as a hold, believing that it will be some period of time before the merger with First Union will show financial benefits. We do believe the new company is well-positioned in many key territories and has a good product mix to succeed in today's banking environment -- but think it will take time for investors to become comfortable with the new operating structure at the bank.

Q: How far out into 2002 do you think the recovery will come for your area -- and the rest of us?

A: (Cathy)

In general, the earnings comparisons will be easy once we hit the second quarter of 2002. You may start to see tangible proof of a recovery then. The stocks of many financial-services companies may be poised for a recovery in early 2002, assuming we don't see evidence that the recession becomes deeper or more protracted.

Q: What about J.P. Morgan Chase (JPM )?

A: (Steve)

JPM is the only money-center bank that we are currently favoring. We think that their domestic focus and potential benefits from the merger last year between J.P. Morgan and Chase Manhattan will allow them to maintain earnings momentum relative to peers.

Q: If investors move their money out of stocks and into Treasuries, for example, who in the sector will benefit? Or perhaps into bank CDs (just not mattresses)?

A: (Steve)

To the extent that money moves back into safer investments such as CDs, some banks will benefit. Also, banks that do a substantial amount of transactions with government securities markets, such as Bank of New York (BK ), could benefit.

Edited by Jack Dierdorff

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