Stop putting them in the same category as unicorns and the Loch Ness Monster. A well-performing financial stock is no myth.
As the credit crisis continues, however, financial sector outperformers are exceedingly rare and hard to find. BusinessWeek relied on data provider Capital IQ (like BusinessWeek, a unit of The McGraw-Hill Companies (MHP)) to identify U.S. stocks in the financial sector that fit this criterion.
There are 376 financial or investment firms listed on major U.S. exchanges of a significant size—i.e., market capitalizations of more than $500 million. (And there used to be many more—just ask National City, Wachovia and Merrill Lynch.)
Of those 376 stocks, only 10—2.7%—have not lost value since the start of the credit crisis, in mid-July 2007. In contrast to these standouts, the S&P 500 Financial Sector Index, a gauge of the fate of large-cap financial stocks, dropped 78% from July 15, 2007, to Feb. 26, 2008.
Capstead Mortgage Outperforms
Perhaps most impressive are those financial stocks that made money for investors while also specializing in mortgages and banking. Though at the epicenter of the credit and housing crises, these firms managed to boost earnings. And without the need for government bailout money.
Capstead Mortgage Corp.'s (CMO) very name is enough to scare mortgage-phobic stockpickers. But its stock is up 6% since the crisis began. Shares have rebounded almost 19% from the market lows of November 2008—lows the broader market slipped back below on Feb. 27.
Capstead, a real estate investment trust, or REIT, accomplished all this by investing primarily in mortgages guaranteed by the government-sponsored Fannie Mae (FNM) and Freddie Mac (FRE), or by the federal agency Ginnie Mae. Though most were adjustable-rate mortgages (a loan variety that has seen its reputation tarnished by the crisis), the implied backing of the government means Capstead was investing in the very safest end of the mortgage market.
Also, the steep drop in interest rates means wider profit margins for Capstead. It can borrow for cheap while lending at a higher rate. "It is hard to see how earnings don't improve materially in 2009," Sterne, Agee & Leach analyst James Ackor wrote on Feb. 2 after the company released quarterly earnings.
Smaller Banks Avoid Big Trouble
Another mortgage REIT with similar characteristics is Annaly Capital Management (NLY). It also invested in government-backed mortgages, and its stock has held its value—up 1.7%—from the start of the credit crisis.
None of these stable financials is a household name, and perhaps that's not surprising. Veteran banking analyst James Schutz, also at Sterne, Agee & Leach, notes that it seems as though the larger the bank, the larger the losses it incurred in the credit crisis.
Smaller banks steered clear of complex, toxic investments. And though more than a few got tripped up in loans to developers, many small, local banks are doing pretty well, Schutz says.
"The general rule is that the smaller banks know their customers better," Schutz says. "The CEO of Bank of America (BAC) is not going to church with his customers."
Conservative Style Benefits UMB Financial
UMB Financial (UMBF) is a $3 billion bank based in Kansas City, Mo., with operations across a wide stretch of the heart of the U.S., from Arizona and Colorado to Oklahoma, Nebraska, and Illinois. So it's hardly just your neighborhood savings and loan.
Still, UMB's lending has been so careful that it has avoided almost any significant trouble. The stock is up 3% since the start of the crisis, and the bank didn't take government bailout funds.
UMB Chief Executive Mariner Kemper explained his bank's philosophy while unveiling end-of-year results on Jan. 28. "We know our customers. We lend to businesses with strong balance sheets and income statements. We lend within our footprint, and we do not go through intermediaries," he said. "Loans stay on our balance sheet. While it may sound simplistic, we stick to what we know, a philosophy that has served us nearly 100 years."
But investors haven't always been impressed with this conservative philosophy.
"While today the numbers look very good," Schutz says, "in good times, their performance has looked mediocre." While peers were posting great earnings results in the good years, investors were criticizing UMB for not making enough loans and for too much overhead.
The credit crisis has flipped this logic on its head. What once looked like the financial world's dinosaurs could be its future. While bigger, more aggressive rivals collapse or go begging to U.S. taxpayers, these rare specialists in safety and stability—and their shareholders—get a modest reward.
|Market Capitalization ($M) [Latest]||Share price gain (%) since start of credit crisis*||Share price gain (%) since Nov. 19, 2008|
|Capstead Mortgage Corp. (CMO)||Mortgage Real Estate Investment Trust||638.9||5.86||18.6|
|UMB Financial Corp. (UMBF)||Financials||1,599.8||3.22||0.515|
|Annaly Capital Management, Inc. (NLY)||Mortgage Real Estate Investment Trust||7,794.1||1.71||14.8|
|S&P 500 Financial Sector Index||(78.0)||(31.0)|
*From July 15, 2007.