Obviously, finance companies highly exposed to the mortgage crisis are suffering, but financials overall aren't doing so badly thus far in 2008. What do you make of this?

On the other hand, some other banks like Westamerica Bancorporation (WABC), Wilmington Trust (WL) and BB&T (BBT), that have relatively lower proportion of housing related loans in their portfolio and/or derive a significant share of their revenue from fee based businesses, reported their earnings which were in-line with or slightly ahead of our estimates. We also saw some of these companies benefitting from the Fed's actions as their net interest margins expanded due to the lower rates on their borrowings.

One of the companies you cover is Freddie Mac. Where do you think this company is, currently, in this mortgage-lending downcycle?

Freddie Mac's (FRE) first quarter results were better than expected, mainly aided by the accounting changes. The company also announced a capital raise of $5.5 billion and we suspect that they will need to raise more capital in the coming quarters. Moody's recently downgraded FRE's financial strength rating and placed them on a negative outlook. Falling housing prices and rising delinquencies are expected to keep the credit related expenses high in the near-to-medium term.

Though recent regulatory moves raising the limits on the conforming loans and lowering the capital requirements are expected to be somewhat positive for the earnings, they will greatly increase the risk for the company. However, we anticipate that the regulators will continue to support both Fannie Mae (FNM) and Freddie in their role as the providers of liquidity in the housing markets. Though we are very much concerned about the increasing risk profile of this company, we anticipate that the implicit Government backing will continue to support the share price.

Do you see the new federal student loan market stabilization plan helping companies like Sallie Mae (SLM) in the near term?

Yes, we think that the plan should benefit the student lenders. In the recent past, the student lenders suffered as the provisions in the College Cost Reduction Act and Higher Education Access Act reduced the subsidy, increased origination fees and reduced government guarantee for these companies. At the same time, liquidity issues in the markets increased the cost of funding substantially. The new legislation would allow the Education Department to buy federally guaranteed student loans that the lenders are unable to sell as a securitized debt. This would ease the problems for these companies in the near term.

How would you advise investors who are considering dipping a toe back into the waters of financial stocks?

Our view has not changed, as we would continue to advise investors to remain cautious on this sector as of now. At this point of time, it is difficult to say how much further losses will be seen on the mortgage/housing-related loans and to what extent the payback problems starting from mortgage meltdown affect the other kinds of loans.

Some of the banks that had been buying back shares aggressively during 2007 (which supported EPS to a great extent), will now focus on capital preservation and thus we expect minimal share buyback activity during 2008. We can also expect some more capital raises and dividend cuts as the banks try to shore up capital.

All-in-all, things do not look very positive at least for the coming couple of months. After viewing the second quarter results, we may have a greater visibility on the mortgage and housing situation, and we may then find some great bargains among the financials.

Neena Mishra is a Zacks senior analyst covering financial and insurance companies for Zacks Equity Research.