T. Rowe Price fund boldly buys banks -- hedges bets

By Joseph A. Giannone

NEW YORK (Reuters) - T. Rowe Price Financial Services Fund manager Jeff Arricale is making bold bets on some of the industry's hardest hit stocks, confident big banks and brokers will climb out of the current turmoil.

Just not any time soon.

During the past year, he has invested much of the $321 million T. Rowe Price Group Inc (TROW.O) fund to help recapitalize Merrill Lynch & Co Inc MER.N, Citigroup (C.N) and Lehman Brothers Holdings Inc LEH.N, even as financial benchmarks limp along near 10-year lows.

Investors have worried that one-time giants like Lehman may not be strong enough to get through the credit crisis in one piece. Yet Arricale says he's betting some banks will reemerge stronger after two or three years.

"We're not just throwing darts," he said in an interview. "Either we think these banks don't need to raise more capital, or if they do, they would be funded."

The Baltimore-based investor rose through the ranks as an analyst, making waves in 2005 when he criticized former Morgan Stanley (MS.N) CEO Philip Purcell. He was also outspoken about the need for change at H&R Block (HRB.N), a tax preparation firm hobbled by mortgage losses.

Like other bank sector funds, Arricale's portfolio has plunged for the past two years, thanks to such names as Citi, Bank of America Corp (BAC.N), Merrill and National City Corp NCC.N. And the near term outlook remains grim.

"When we look at the financials, it's difficult to call where the next move is. If I had to guess, I'd say it's down," he said.

Yet looking down the road, Arricale believes these stocks will recover and then surge. Recent net inflows suggests investors agree it's a good time to buy financial stocks, despite the current turmoil.

That gives him confidence to hold Citi shares. Arricale says the bank, his second-largest position at about 5 percent of the fund, could double to more than $30 a share in a few years if it could get earnings back to 2004 levels.

Arricale has invested 2 percent of the fund in Lehman, which continues to plunge amid rumors of more losses, desperate asset sales and more capital raising. Arricale argues the stock is very cheap and remains a good franchise.

"If they need to raise capital in conjunction with a deal that rids their balance sheet of some toxic assets, I'd probably be quite willing to add to our position," he said.

There are many stocks said he won't buy, notably Freddie Mac (FRE.N), Fannie Mae (FNM.N) and American International Group Inc (AIG.N).

"Right now we're avoiding companies where we think there needs to be additional capital raises and we're not sure that the market wants to fund them," he said.

Any investment in Fannie and Freddie, stocks that have been hammered on mortgage losses, would be based on faith that the United States will not wipe out stockholders in a bailout.