As large-cap bank and brokerage stocks keep falling, some investors and analysts recommend least a partial shift to the “values” represented by smaller-cap and regional banks.

Henry S. D’Auria, the director of research at Sanford C. Bernstein & Co. and portfolio manager for the Enterprise Global Financial Services Fund, said he shifted his focus from the big players because regional banks provide less credit risk and are generally cheap.

“Regionals are the definition of value stocks,” he said.

Investing in a smaller-cap bank is a winning game even if the bank has not diversified, he said. “Some of them have diversified well,” he said, and those that have not are potential takeover targets.

Richard Bookbinder, managing member of Bookbinder Capital Management LLC, a fund of funds, said diversifying a portfolio “away from money-centers and into regionals is a good idea.

“Consolidation will continue as long as currency is available,” he said.

Large-cap banks took a hit Thursday in a weak market session. Dow Jones reported that Merrill Lynch & Co. analyst Judah Kraushaar had said bad syndicated loan and high-yield underwriting could reduce the per-share earnings of major banks and brokers by 5% next year — and possibly more at Chase Manhattan Corp. and Lehman Brothers Holdings Inc.

Citigroup Inc. held its ground, while many banks fell along with the Dow Jones industrial average. Steven Eisman of CIBC World Markets reiterated his “buy” ratings for Citi and Morgan Stanley Dean Witter & Co. and his “strong buy” ratings for Lehman Brothers Holdings Inc. and Merrill.

Mr. Eisman was less generous with Chase and Bear Stearns Cos., cutting both two tiers from “strong buy” to “hold.”

He said the downgrade of Chase was for the “obvious reasons,” addressing problems at Capital Partners, while Bear Stearns was reduced because “it lost market share in the U.S.” Chase closed down $1.0625, or 2.8%, at $36.875; Citi gained 37.5 cents, or 0.76%, to close at $49.8125.

Mike McMahon, an analyst at Sandler O’Neill & Partners, agreed that smaller banks are a good place to be right now. He said that they provide not only a safe haven for investors, but long-term investment opportunities. Their exposure to potentially troubled credits is low compared with that of their big brothers, he said.

Smaller banks’ diversified loans within their communities means low yield but also low risk, Mr. McMahon said. In a time when asset quality is a major investment concern, knowing your customers is an advantage, he said.

On Thursday, Mr. McMahon initiated coverage of Pacific Capital Bancorp of Santa Barbara, Calif., with a “buy” rating, Sandler’s top grade. He said he is impressed with the management and the company’s market share in deposits.

“It is very important for community banks to be among the top three in deposit market share,” he said. After several mergers and acquisitions, the $3.6 billion-asset company is among the leaders in all four counties where it operates. Its 25% share in Santa Barbara leaves Washington Mutual, with 15%, in second place.

Pacific Capital was down 31.25 cents, or 1.2%, on Thursday, closing at $25.6875.

Mr. D’Auria said his favorites are Huntington Bancshares, selling at $15.25, up 43.75 cents, or 2.95%, and Regions Financial Corp., selling at $24.25, up 25 cents, or 1.04%.

Subscribe Now

Access to authoritative analysis and perspective and our data-driven report series.

14-Day Free Trial

No credit card required. Complete access to articles, breaking news and industry data.