JEFF ARRICALE, a mutual fund manager at T. Rowe Price, left Baltimore in March and took a train, the subway and two airplanes all told, a 20-hour trip to ultimately arrive at a makeshift burlap lean-to in Morocco at the starting line for the Marathon des Sables, one of the most grueling races in the world. Runners cover 156 miles in the Sahara Desert and traverse massive sand dunes and hard flats littered with jagged rocks. And they do it while enduring scorching 120-degree temperatures. Arricale spent months training for the event and eventually completed it in six days. Later, he said it was "one of the most humbling experiences of my life."

Arricale may seem like a glutton for punishment, especially considering what he was experiencing back at work. Twelve months prior to running the race he was promoted to manager of the $350 million T. Rowe Price Financial Services fund, giving him a front-row seat to the unprecedented tailspin that industry experienced. He may have crossed the finish line out in the desert, but by many accounts he is far from putting the chaos at work behind him. Indeed, as he took control of the fund he watched as seemingly overnight some of the companies he owned wrote down the value of billions of dollars of assets and, in the case of Bear Stearns, ceased to exist after eight decades on Wall Street. All that was enough to make a run through a barren wasteland seem like a nice break.

Arricale had put together successful stints as an analyst at T. Rowe and as co-manager of the firm's well-respected Capital Appreciation fund, helping steer that charge to a top 10% position in its Morningstar category. In his new job he helps oversee a team of analysts whose research on financial-services stocks finds its way into the hands of the firm's marquee managers. In other words, there is a lot riding on Arricale and his team getting it right. That means doing homework lots of it. As many talking heads speculate on TV about whether financials have hit bottom, Arricale has quietly stuck by the tried and true research methods that have been the hallmarks of his employer for over 70 years. And that seems to have stemmed the bleeding just a bit. The fund lost 9.4% last year and is down 19.8% in 2008. This year's tally beats 70% of the competition, according to Morningstar.

With that in mind we conducted several interviews with Arricale over a six-month period to get his thoughts on the lessons he's learned from the protracted credit crisis and which financial-services stocks will be left standing when the smoke finally clears.

SmartMoney: Why did you compete in such a grueling race?

Jeff Arricale: I was raising money for Opportunity International, the Maryland Chapter of the Special Olympics and Johns Hopkins Children's Center. I have two kids with a lung disease who have been treated [at Hopkins]. I want them to see their mom and dad being healthy and active. I want them to aspire to do the same even if they have some physical limitations. We have raised $70,000 and we aren't done yet.

SM: When you started this job the market took a turn for the worse. What was your first inclination?

JA: It was to be defensive. I took down some positions in banks and I added more cash. I also included some nonfinancials in the portfolio. General Electric and Tyco were big contributors over the last year. I have since taken those positions down to 2.5% of the fund from 10% as financials have increasingly become compelling values. I eliminated GE at an average price of $38.42.

SM: Price/book failed when you couldn't value some assets. What happened?

JA: I use price/book a lot in financials. And I think in most sectors price/book works. However, during times of distress at financial-services firms their assets are inherently fragile. Companies were awash in liquidity in 2005 and 2006. But when there is no market for those assets you can't sell them. Contrast that with an oil or gold company. It's easy to put a price on a barrel of oil or an ounce of gold. Liquidity is now front and center [for us]. A perfect example of that is Sallie Mae. Sallie Mae is a great buy if the securitization market for student loans opens up again. If it doesn't, it's a terrible stock. I am waiting to buy it.

SM: Can you give us your take on the troubles at Fannie Mae and Freddie Mac?

JA: We cut our losses to them. The problem with the GSEs [government-sponsored enterprises] is we really have no way of handicapping what the ultimate government solution is going to be and with the majority of those solutions it doesn't bode well for equity holders, although fixed-income shareholders should be fine. When Freddie ultimately raises the $5.5 billion of capital it has committed to raising, we will take a fresh look.

We are getting our housing-related exposure through home builders and regional banks. With the home builders we feel there is some real estate and some actual dirt there real assets that have some value. And with the regional banks we feel like a lot of the companies that have raised capital and significantly increased their loan-loss reserves are good buys.

SM: What have been your biggest mistakes during your first year as manager?

JA: I weighed into the bond insurers. At one point I had over 2% of the fund in bond insurers. I no longer own any of them. I can sit here and defend my investments in Citigroup or Merrill. I can't defend my investment in the bond insurers. I got it wrong.

SM: You also owned Bear Stearns.

JA: We started buying Bear Stearns after some of its hedge funds blew up last summer. We saw an investment bank that had been around for almost 100 years starting to trade at a huge discount to book value. We thought it would just ride out the credit storm like it had in the past. It turned out it was a huge mistake because counterparties lost confidence and the Fed was forced to act to the detriment of Bear Stearns' equity holders in order to shore up the financial system. We sold the investment at around $6 a share.

SM: Are you bullish on Citigroup?

JA: It's a cheap stock and a controversial stock with a great deal of near-term uncertainty. Also there is a new management team. As a value investor all those things gets me interested. It has a world-class consumer banking franchise. It has one of the best retail brokerages in Smith Barney. And it has raised almost $44 billion.

This is a company with about $3.50 of earnings power in 2010. I think it can trade at 10 or 11 times earnings. That gets you to a $35 to $40 stock. I have a pretty good chance to have a 100% return over the next two to three years. There is value there whether it is paying me a dividend or not. Although Citi is over 5% of the fund, half of that is in common stock and the other half is convertible bonds with much lower risk.

Citigroup -- 1 year performance

SM: What about H&R Block?

JA: It has a new management team in place that has cleaned up the balance sheet. What got this company into trouble was its foray into mortgage lending. It sold that business and it has adequate reserves against legacy liabilities related to it. Its core tax business, which was suffering market share losses, has really turned around. The tax-prep industry in the U.S. grows about 1% a year. [H&R Block] should grow as fast or faster. On top of that, they usually raise prices 6% to 8% a year. So right there you have a 7% to 10% top line growth, which is pretty good for a mature company.

SM: There was talk earlier in the year that Lehman was another Bear Stearns. You don't agree, right?

JA: One reason Bear went the way it did was because the market didn't have confidence in senior management. Market participants feel that Lehman's management is very engaged. Bear Stearns had the third-largest prime broker. [At the end] a lot of folks wanted their money back. Lehman doesn't have that kind of fast money. If I look at the market cap right now of about $10 billion, its asset-management company Neuberger Berman is arguably worth $7 billion or $8 billion and here you have an investment bank leading in league tables, gaining share in M&A on a global basis and the stock trades at a fraction of book value. It is obviously risky, but we think the bank has the wherewithal to make it through.

SM: Last month Wells Fargo's second-quarter earnings report touched off a mini-rally. What did you make of the market's reaction?

JA: That wasn't a mini-rally it was gigantic. It was a function of a few things: Hedge funds declaring victory and covering shorts; traditional mutual fund and institutional portfolio managers who are underweight financials taking a look and saying, "I don't know if I want to dip down into the more speculative names, but geez, it makes sense to own Wells Fargo or Bank of America or Citigroup here." [There's] some legitimate value in these names if you can look further out.

SM: What are your impressions of the actions the Federal Reserve and the Treasury have taken during all this time?

JA: I actually think [Federal Reserve Chairman] Ben Bernanke and [Treasury Secretary Henry] Paulson are doing a solid job in an unprecedented and extraordinarily difficult time. And I think they are between a rock and a hard place with inflation and with the contraction in the economy. Obviously we don't know ultimately what the end game will be and whether they are going to be successful, but they seem to be balancing things well.

SM: So is the worst over?

JA: I think we are a significant portion of the way through it. Over $400 billion in capital has been raised. So the worst has probably passed us in terms of emergency capital-raising. The high yield bank debt market has loosened a bit. Bonds are starting to trade. The rest of '08 is going to be lousy; '09 there might be a lift from very distressed levels, but it's not going to be robust returns. I am thinking probably not until 2010 are we going to see good earnings. Housing prices are one of the most important data points we are watching. The latest data indicates we may be bumping along a bottom.

SM: Going forward, how are you positioning the portfolio?

JA: The market is forward looking. Stocks will move well in advance of [a rebound] in fundamentals. What we are trying to do now is focus on fundamentals, focus on balance sheets and find banks that are going to survive any near-term liquidity shocks and then ultimately have the wherewithal to continue to grow their loan book and make money.

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