Financial Services: Value Amid The Carnage?

But "buyer beware" remains the rule

Is it safe yet? That's the question many money managers are asking about financial-sector stocks. Banks and brokerages--including Lehman Brothers, J.P. Morgan, Citicorp and Republic New York--have been among the most heavily wounded in the market carnage this summer. But, contends James Ellman, manager of AIM Global Financial Services Fund: "A lot of babies have been thrown out with the bathwater." In other words, it could be time for some financial stocks to stage a comeback.

But there's good reason for the market's skittishness. Each week brings fresh news of more billions lost by bankers and traders in Russia, Asia, and other emerging markets. Then there's the prospect of slower growth at home. Many fund managers remain leery of money-center banks. But they say that many regional banks, brokerage firms, and mutual-fund companies are good values at today's prices.

FREE FALL. How bad has the sell-off been? The Standard & Poor's Financials Index is down 23% from its 52-week high. While the Standard & Poor's 500-stock index trades at 24.6 times estimated 1998 earnings, the financials index is just 16.5.

The discount may be deserved: Analysts are working overtime to cut earnings projections for banks and brokers. At the beginning of July, analysts expected 9% earnings growth in 1998 from brokerage companies--but now they expect no increase for the year. Several weeks ago, analysts were predicting flat earnings for brokers for the third quarter, but they now expect earnings to fall 32%, according to First Call Corp. For money-center banks, analysts are looking for a 26% profit drop for the third quarter.

Some of the most brutal market blows have been felt by the big banks. David S. Berry, director of research at Keefe, Bruyette & Woods Inc., says bank stocks are being pummeled the way they were in the 1980s, when they had less capital and lower profits. But, Berry argues, the industry is in "rather better condition" this time.

That may be, but it doesn't diminish the risks that the banks still face from the emerging-markets meltdown. "What you need to see is a clear solution to the offshore problems," says Thomas Goggins, manager of the John Hancock Financial Industries Fund.

Analysts are more bullish on regional banks, which aren't as exposed to overseas turmoil. Even Charles Peabody, the Mitchell Securities analyst who has been warning for more than a year that bank stocks could face big problems, is recommending PNC Bancorp and Fleet Financial Group. Berry prefers First Union Corp. Michael J. Stead, portfolio manager for SIFE Trust, is a fan of Hibernia Corp., a Louisiana bank hurt because of some exposure to Latin America. He has faith in the bank's CEO, Stephen A. Hansel, who "has a very keen eye for maintaining loan losses to a minimum and has done a great job of redoing the bank."

RUMORS. Investors have been far more worried about brokerage stocks. "Conditions were so uncertain at one point for the global houses that even the faintest hint of bad news tended to be overplayed," says Financial Service Analytics analyst Michael A. Flanagan. Lehman Brothers, for instance, was rumored to be filing for bankruptcy protection--a rumor the firm denies and analysts believe is unfounded. Merrill Lynch & Co. has taken some trading losses, and more hits are possible. But to justify the beating the stocks have taken, "you have to assume that this is permanent, that the big bull market of the 1980s and 1990s is over," says Raphael Soifer, bank analyst at Brown Brothers Harriman & Co. "If the market is going to turn around and we are going to have a generally good market in 1999, these stocks are cheap."

Of course, that's a big if. And even now, brokerage stocks trade at relatively lofty price-to-book-value ratios, says Dean Eberling of Putnam, Lovell, de Guardiola & Thornton. One exception is Lehman Brothers, which trades at a price-to-book ratio of 1.5--a level not seen since 1990. Eberling says the hit to Lehman's stock is overdone and that the company has done "a fabulous job of recasting itself over the last three years." As for Morgan Stanley, he cites its "great franchises" and "strengthened position in the global game." Ronald Elijah, manager of the Robertson Stephens Value + Growth Fund, bought Charles Schwab recently, still likes longtime holding Merrill Lynch, and is looking at other brokers "because they're down so much."

THE BOOMER CARD? Mutual-fund companies aren't escaping the bloodbath, either. As portfolio values drop, so do earnings. But some fund managers vow their firms are now unfairly undervalued: Affiliated Managers Group Inc. announced on Sept. 11 that it would buy back up to 5% of its shares. AIM's Ellman likes Alliance Capital Management and Franklin Resources for their large fixed-income and money-market operations. "We know the boomers will keep retiring," he says. "They'll have to put their savings somewhere. If it's not in the stock market, it will most likely be in the fixed-income market." At 29 7/8, Franklin is down 48% from its 52-week high and down 29% for the year. Alliance, while down 23% from its 52-week high, is up 17% for the year.

American Express Co. has also suffered. Its stock is down 28.4% from its 52-week high. Babson Value fund manager Nick Whitridge, a longtime holder of the stock, thinks that with long-term earnings growth potential of 14% a year, and a price-earnings multiple of about 14.5 times estimated earnings for 1999, the stock is "a reasonable value, not really dirt cheap."

Sure, if the international crisis abates and the market continues to rebound, these financial stocks may turn out to be screaming buys. But for now, investors might want to wait until the picture becomes clearer before betting the ranch on the newly volatile sector.

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