Bank stocks, anyone? We can hear you shuddering. The financial services industry has easily been this bear market’s most reviled and unloved sector. Some of its former giants are now shrunken, cracked shells of the powers they once were.
The market has shunned virtually all financial companies this year, but that very punishment has created some interesting values, says Jason Tyler, Ariel Investment’s head of research operations and the Chicago investment firm’s in-house financial stock analyst. Tyler’s not looking to jump in with the big banks whose bailout needs make headlines daily. His mission at the value-investing firm is to sift through the heap to find good businesses that are lumped with the group’s derelicts.
Ariel has always had a soft spot for financials. Tyler says both the company’s Ariel and Ariel Appreciation mutual funds have approximately a 33% weighting in the industry. Ariel’s taken a shine to companies at all levels of the financial services industry, too. The firm has stakes in banks with a stock market value as small as Private Bank, with a $400 million capitalization, and as big as J.P. Morgan Chase, with a market cap of $100 billion.
Black Enterprise: What’s your take on the maelstrom in the financial industry?
Jason Tyler: In many ways, it’s an exciting time, a once-in-a-generation opportunity. Don’t get me wrong–we’re in a big, big
storm and you want to avoid 99% of the companies in the financial industry right now. The storm is real, and financial services companies face a tough time in the next year. Still, if you do your homework, there’s a chance to pick up some great bargains.So where do you draw the line between good and bad in a business that’s so wracked in turmoil?
For starters, we’re focusing more than ever on companies that took a conservative route when everybody else was getting greedy. A few years ago, there was a fork in the road; many banks took the path into risky investments, but not everyone went down the same road. The quickest example is J.P. Morgan Chase, Citigroup, and Bank of America. Three years ago, all three were about the same size and stock market value. Fast-forward and you see two in trouble:Â One, Citigroup gave up control to the government. Another is the severely weakened Bank of America; and J.P. Morgan Chase seems to have the conservative makeup that has helped it hold on. There are conservative banks out there with sound businesses that can do well relative to their peer group and that can stay positioned to outperform when the economy finally gets on firmer footing.
What survival signs are you looking for?
If I had to generalize, there are
certain characteristics that they have in common. We’re looking for institutions with lots of capital on the books. We’re drawn to companies that haven’t taken on a lot of debt. We’re impressed by well-run operations in steady sectors, too. And let me say that many of the same criteria apply to the broad market as well.So what’s a good example of a financial company that meets those criteria?Jones Lang LaSalle (JLL) is one name that we like. It’s a Chicago real estate brokerage, management, and investment firm. We know the company and its executive team quite well–their headquarters are in the same building where Ariel is based, so we get to see their work as property managers firsthand. The company has a global reach with 30,000 employees in 750 locations in 60 countries and it runs a lucrative business based on high-end properties. It’s not a real estate investment trust or REIT, but it does generate revenues of leasing and selling properties, as well as managing office buildings. JLL has a strong balance sheet and a very low debt to cash flow number, which means management can sidestep the credit crunch. They simply don’t have to borrow in order to withstand declines in revenues. The thing that jumps out at us is that at the end of February, the stock was trading at below six times its forward earnings projection for 2009, which is very cheap.
We think profits can rebound to $3 to $3.50 a share from just under $2.50 last year. Here’s a sign of how strong Jones Lang Lasalle’s reputation is: The day the company reported earnings and a drop in revenue this past February, the stock still managed to jump 18% simply because management met Wall Street expectations and didn’t surprise investors with negative news.
Are there any conventional banks that fit your profile?
A local bank, Private Bancorp Inc. (PVTB) is a stock we own and like right now. It’s a Chicago-based commercial bank with an interesting story. Most of its senior managers–the CEO, chairman and about 100 other top-level bankers–came over from a very reputable outfit, LaSalle, when that bank was bought out by Bank of America in late 2007. I’d say it’s an upper-echelon story, much like Jones Lang Management has set out to replicate the success and reputation that made LaSalle such a strong institution. Commercial banking is a relationship-based business, too, and PVTB has benefited from the deep ties its new management had with clients. PVTB is conservatively run and while management avoided the type of poisonous derivatives that hurt the nation’s biggest banks, the firm still had to take its medicine and write off a lot of bad loans in the fourth
quarter of 2008. And while that’s now behind them, the stock is selling at 60% of the company’s book value, or the price management could fetch in a fire sale of its assets like deposits and office equipment.Is steering clear of consumers, checking accounts, and deposits the only safe way to go when investing in banks?
No. In fact my third pick, City National Corp. (CYN) is a very conservative bank with what you could call a traditional line of business. It’s based in Hollywood, and many investors call it the bank of the stars. It has a great deposit base, arguably the best in the country–the very type of capital many banks would die to have. City has taken a drubbing, however, because of concerns about real estate lending in California. By some measures, however, the value of City’s mortgage loan portfolio as a percentage of the worth of the real estate property is very low, which should provide the bank an adequate cushion to any further decreases in home values. We think the company could earn $2.50 a share in 2010, which would help its share price jump from current levels, particularly if some of the bigger companies like J.P. Morgan Chase and Wells Fargo turn the corner by then.
This story originally appeared in the May 2009 issue of Black Enterprise magazine.