Are Financials Still At Risk?

By Todd Shriber | January 13, 2009 AAA

The marquee Wall Street story of 2008 involved the financial sector and its precipitous decline at the hands of risky, convoluted financial instruments tied to the mortgage market. Whether it is investment banks that are gone forever or other financial institutions that were kept alive solely because of taxpayer assistance, 2008 will be remembered as the year that forever changed the landscape for American financial firms.

The most prominent stories concerned the demise of Bear Stearns and Lehman Brothers in the investment banking arena. Not to be outdone, mortgage giants Fannie Mae and Freddie Mac, along with insurance goliath AIG, imploded. And Citigroup, formerly the largest U.S. bank, was pushed to the brink of disaster. Needless to say, investing in ANY financial institution in 2008 was a fool's bet. But some names with long-term potential were jaundiced simply because of their industry status and a bad economy, not because of poor management or weak underlying fundamentals. (Get to know a little bit about the institutions that guide free markets in The Rise of the Modern Investment Bank.)

Let's examine a different kind of financial for value opportunities:

Institution Price/
Book
Current
P/E
Bank of New York Mellon (NYSE:BK) 1.1 15
Federated Investors (NYSE:FII) 5 8
Northern Trust (Nasdaq:NTRS) 2.3 19
State Street
(NYSE:STT)
1.4 9




Source: Thomson Financial Networks

Custodian Kings
Bank of New York Mellon and State Street are the two biggest U.S. custodian banks. While their services and business lines reach far beyond the typical custodial services, the two rivals are probably best known for their bread-and-butter business of safeguarding financial assets on behalf of institutions and individuals.

While Bank of New York Mellon and State Street do not have branches or offer many of the services offered by traditional money center banks, they also cannot be considered investment banks. And that's good news for investors. Both firms are among the leaders in listing American depositary receipts (ADRs) of foreign public companies and State Street is among the leaders in issuing exchange-traded funds (ETFs).

Bank of New York Mellon was designated by the U.S. government to monitor the now infamous Troubled Asset Relief Program (TARP). The company also received $3 billion from the program. Both Bank of New York and State Street appear intriguing for several reasons. First, both are well-capitalized with relatively low credit risks, which is a major plus for investors seeking opportunities in financials. In addition, both are well-positioned globally. Citigroup recently initiated coverage of both firms with a "buy" rating. (For further reading on this topic, check out Analyzing a Bank's Financial Statements.)

Northern Exposure
Northern Trust competes head-to-head with Bank of New York and State Street and the company's ride during the financial contagion was just as wild, if not more so. The company's shares have traded between $34 and $89 over the past 52 weeks, but settled toward the lower end of that range at just over $50 as of Friday's close. The company announced in late September 2008 that it had exposure in the Lehman Brothers debacle, which likely sent shareholders scurrying for exits.

Despite that obstacle, Northern Trust shares still trade at a P/E level that is in line with its peer group and at a substantial premium to the broader market. Therefore, these shares may not offer the same value as those of Bank of New York and State Street. The same Citigroup analyst that rated Bank of New York and State each a "buy" tagged Northern Trust with a "hold". By now, most investors realize the specious nature of analyst ratings, but some homework on your own will likely reveal that both Bank of New York and State Street are superior investments to Northern Trust at this time. (Read more about analyst ratings at Analyst Recommendations: Do Sell Ratings Exist?)

A Find With Federated?
Federated Investors was another victim of the 2008 calamity in financial stocks, shedding close to 60% of its share price. Federated could present investors with a truly unique opportunity, however. Wall Street seems to be glossing over the fact that the asset manager is actually gaining assets, which is no small feat in the current economic environment. Furthermore, fair value for Federated's shares comes in around $29, almost 50% higher than the current trading price of $19. In addition, short-term interest in Federated shares has been rising rapidly, meaning investors with a higher risk tolerance and shorter time horizon could benefit from a short-covering rally.

Bottom Line: You Don't Need A Bank To Make Money In Financials
If 2008 has taught investors anything about financial stocks, it is that trust can easily be violated by management. Recall how management from Bear Stearns and Lehman Brothers tried to convince us that their institutions were fine, almost on the eves of their demises. Or bring to mind Bank of America's (NYSE:BAC) wanton disregard for shareholder value by acquiring troubled firms such as Countrywide and Merrill Lynch, and then slashing its dividend by 50%. The list goes on. On the bright side, however, 2009 could be a stock picker's paradise. Bank of New York and State Street offer relatively safe avenues for investors to give their portfolios exposure to financials.

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