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By Jeremy Glaser | 08-09-2011 04:25 PM

Tough Environment for Banks, but Stocks Look Cheap

Low interest rates and an anemic economy will weigh on bank earnings, but much of the bad news is already priced into stocks, says Morningstar's Jim Sinegal.

Jeremy Glaser: For Morningstar, I am Jeremy Glaser. Bank stocks had one of their worst trends since the height of the financial crisis over the last week. I'm here today with the Morningstar's associate director of banks, Jim Sinegal to take a look at what's happening.

Jim, thanks for joining me today.

Jim Sinegal: Thanks for having me.

Glaser: So, can you just give us an overview of why are the banks selling off so strongly, and even more than the broader market?

Sinegal: I think there are a few reasons. I think, number one, perhaps, obviously, in some ways, maybe not so obviously in other ways, was the Standard & Poor's downgrade of the U.S. government debt. I think the major fear there originally was that it would have effects on banks' operations. I don't think that's a big problem. What I do think is the implications of the cut on government spending. I think S&P said that the government had cut spending and less than S&P had wanted it to.

There is a lot of political pressure to cut spending. Something I've been telling people, I think the market is Keynesian and definitely did not like the idea of government spending cuts. I think that's why Treasuries were up; I think that's why the stock market was down. And those deflationary pressures are really bad for banks and as compared to the market in general.

I think the second reason obviously is the legal risks have kind of come to the forefront again. BofA looked like it had reached the settlement on mortgage putbacks. Now AIG is suing BofA. The New York Attorney General is after BofA. So, a lot of these mortgages issues that investor thought were put in the past or maybe not as far behind as we thought.

Glaser: So, we certainly have been talking about bad loans and the mortgages in particular for it seems like a few years now; it has been a few years now. Have most of banks really put this behind them? I mean is this just we're hearing a few little, a lawsuit here or lawsuit there or is this still really a large systemic problem that investors in the sector need to be focused on?

Sinegal: I don't think it's a major problem for a lot of the banks. I think that for Bank of America for instance, it's a major problem, because they assume so many liabilities or potential liabilities with the Countrywide acquisition. BofA paid a few dollars, and it got many, many billions of dollars in potential legal liabilities for what they paid. It's a big problem for the firm.

With some of the smaller regionals that weren't mortgage originators, I think a lot of their bad loans are off their balance sheets. The loans made in '04 or '05, they've either charged off or been replaced by new loans, made in 2009 and 2010, and they had much more conservative underwriting standards. So I think for a lot of the smaller banks, a bad loans aren't nearly the problem they were a few years ago.

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