Believe It or Not, Standout Financial Stocks

There actually are companies in the sector—even banks and mortgage firms—that have escaped the credit crisis unscathed. Not many, though

By Ben Steverman

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."