When It Comes to Banks, This Fund Likes 'Em Small

By rights, Raymond Garea ought to like big bank stocks.

As portfolio manager and senior vice president of Franklin Mutual Financial Services, Mr. Garea works with investor Michael F. Price, who helped create one of the biggest banks in the country.

As an activist shareholder, Mr. Price helped usher down the aisle Chemical Bank and Chase Manhattan Bank three years ago.

But Mr. Garea does not think big banks necessarily offer investors top value. Since his fund made its debut last August he has increasingly focused on small bank stocks.

Some of Mr. Garea's biggest positions are in Vermont Financial Service Corp., Brattleboro, Vt.; Warren Bancorp, Peabody, Mass.; UST Corp., Boston; United Security Bancorp, Spokane, Wash.; and Unionbancal Corp., San Francisco.

Smaller positions include Annapolis (Md.) National Bancorp and Regency Bancorp, Fresno, Calif.

The class Z shares produced a 19.71% cumulative total return from Dec. 31, 1997 to May 7, while the Keefe Bruyette & Woods index, which tracks the 50 largest U.S. bank stocks, increased 8.63% over the same period, said Mr. Garea.

Franklin Mutual Financial Services is Mr. Price's first sector fund. It is part of the Mutual Series Group, which is a subsidiary of Mr. Price's financial vehicle, Franklin Resources. That is where Mr. Garea started working with Mr. Price in 1991.

More than 80% of the fund is invested in the stocks of financial services companies. Other investments include preferred stocks, bonds, and convertible securities issued by companies in the financial services industry.

Though the fund has stakes in insurance companies, mortgage companies, and finance firms, it is overweighted in small banks and thrifts, Mr. Garea explained during a recent telephone interview from his office in Short Hills, N.J.

Franklin Mutual Financial Services has $590 million under management.

"We are pleased with the fund's performance ... we are not complacent," he said. "Finding bargain stocks, especially in the domestic market, has become tougher as investors seeking to 'buy the dips' are willing to purchase some stocks at historically high valuations."

Mr. Garea said the best investments are companies trading lower then their peers, yet growing revenues faster than similar companies. To take advantage of consolidation, he said he turns to small banks with strong fundamentals in regions where merger activity is hottest.

However, he said he is cautious and highly selective. "We see considerable downside potential in the stock prices of many of these takeover targets," said Mr. Garea.

He also said he is skeptical about some of the huge bank mergers.

"I think there is more risk in them than people can appreciate," said Mr. Garea. "The most risk is in Travelers and Citicorp because you have companies that are in very different businesses and have different cultures." But he said he does not completely exclude big banks from his investment thinking.

"Just because the bank is big does not mean it's not cheap," said Mr. Garea. Such banks include Chase Manhattan-although it is not among his top holdings-Wells Fargo & Co., PNC Corp., First Union Corp., and Fleet Financial Group.

"I like names where either the stock looks relatively cheap or reasonably cheap," he explained. "And I have to like the business and the business mix.

"I don't want to buy a company where the only way I can win is because it's a takeout target and the fundamentals are not that good. That is the greater-fool theory," he said. "When we own a name it has to be more than that."

Mr. Garea said he felt his strategy was likely to withstand any turns in the market, which he said he believes is too high.

"The market is trading at a higher valuation that it was in 1987," said Mr. Garea. "It doesn't matter that interest rates are lower. What matters is the outlook for growth."

He acknowledged that banks, in general, are much more prepared for a downturn because "they are better at risk management."

Snapping up strong companies that trade cheaply is an investing philosophy passed down from Mr. Price, who is largely credited with prodding along the Chase-Chemical merger.

"Value investing," Mr. Garea said, summing up his investment philosophy, "is the best way to achieve long-term capital appreciation with relatively low risk and low volatility."

For reprint and licensing requests for this article, click here.
MORE FROM AMERICAN BANKER