Nontoxic Financial Stocks

The credit crisis has crimped most banks and other financial firms, but some have actually prospered. How did they survive the subprime storm?

by Ben Steverman

• View Slide Show

It has become a running theme of the credit crisis: Every week another financial firm rushes to raise capital to absorb big losses. On June 9, it was investment bank Lehman Brothers (LEH), which said it would raise $6 billion to help deal with a $2.8 billion second-quarter loss.

Because of the breadth and depth of damage from the subprime crisis, it can be surprising to stumble across a financial firm that has prospered in the past year. But nontoxic financial stocks—those not exposed to the ultra-risky financial instruments that have bedeviled many industry players—do indeed exist.

In even the hardest hit areas of the financial sector—like investment banks, diversified banking giants, or regional thrifts specializing in mortgages—some well-run companies have found ways to withstand the headwinds.

Toughest Environment in Memory

Take U.S. Bancorp (USB), for example. Almost all other American banking giants, starting with the largest ones, Bank of America (BAC) and Citigroup (C), have stumbled in the toughest banking environment in recent memory, but U.S. Bancorp's shares, though volatile, provided a small gain for investors since the crisis began last August.

While many hedge funds took big hits from bad subprime debt, BlackRock's (BLK) funds anticipated and profited from the mortgage and credit problems. Charles Schwab (SCHW) stayed away from the bad debt that wounded its online broker rival, E*Trade Financial (ETFC), and then benefited from its competitor's weakness by signing up new accounts.

Regional firms also impressed investors despite the crisis conditions. In Paramus, N.J., Hudson City Bancorp (HCBK) saw its shares rise almost 40% since August, while UMB Financial (UMBF) in Kansas City, Mo., is up almost 35%.

How have these firms succeeded while rivals faltered?

"It's all about capital," says Don Wordell, portfolio manager of the RidgeWorth Mid-Cap Value Equity Fund (SMVTX). Firms need enough cash to weather tough times, and those that come up short are forced to recruit new investors and issue more stock, which dilutes existing shareholders' stakes.

Debt Means a Loss of Flexibility

Successful financial firms used a variety of strategies to make sure they had enough capital.

U.S. Bancorp, for example, has garnered favorable notice by cutting costs in an already efficient organization. "If you're generating strong profit margins, you've got more room to absorb some credit issues," says Blake Howells of Becker Capital Management.

Another trait of strong financial firms during the credit crisis is low levels of debt, says Terry Morris of National Penn Investors Trust. "The more debt, the less flexibility you have when you have a problem," he says.

But even the most efficient and debt-free firms suffer if losses get too large. When it comes to lending and investing, many firms took risks that, in retrospect, were massive mistakes.