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Are Big Banks a Bargain?

Jeremy Glaser
Jim Sinegal

Jeremy Glaser: For Morningstar, I'm Jeremy Glaser. We've had earnings from most of the big banks so far, and I'm here today with Jim Sinegal. He is the director of financial-services research here at Morningstar. We'll take a look at those earnings and see if the companies' stocks look attractive. Jim, thanks for talking with me.

Jim Sinegal: Good to see you again.

Glaser: Let's start with the most surprising news which was that Citigroup is getting a new CEO. It announced that the day after their third-quarter earnings. Why was Vikram Pandit out? What’s happening there?

Sinegal: Well, we've gotten some more information or at least rumors in the last day or two since Pandit announced his resignation. It was definitely a big surprise at the time. Citi had reported a pretty good quarter in our opinion. It looks like that the resignation stemmed from some problems with the board. Over the last few years, Citi has put into place a really strong board of directors. There are some experienced banking executives, and a couple of directors who have done successful turnarounds. It's a really strong board. It seems like Pandit was clashing with them, and the only way to resolve their dispute was to get Pandit out.

Glaser: So, who is going to be running Citi now, and do you think he's up to the task?

Sinegal: The new CEO of Citigroup will be Michael Corbat. There is not a lot known about him at this point. He was most recently in charge of Citi’s Europe, Middle East, and African operations. Given that Citigroup's focus is on developing in emerging markets, that's definitely good experience to have. [He has] a long background in banking, and at Citigroup that's something that regulators wanted to see and a lot of investors wanted to see.

Vikram Pandit was criticized as not a real banker having come from investment bank. The new CEO has a lot more banking experience, and finally he's spent some time overseeing Citi Holdings. [That's a] pretty complicated mix of Citi's worst assets. It's good to have a CEO that’s familiar with that book as they try to run down the rest of it.

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Glaser: Do you expect any radical changes?

Sinegal: I don't expect any radical changes. From our perspective Citigroup’s strategy has been pretty good over the last few years. It really simplified things and focused on a core strategy of serving global businesses and urban consumers around the world. We think that's a good strategy. We like the new slimmed-down Citi. It's possible that strategy has come more from the board than from Pandit. In that case, we think we'll see some continuity there.

Glaser: Litigation risk has been an overhang for a lot of these bank stocks on worries that the financial crisis isn't totally behind them. We saw that with Bank of America, which took some big charges related to Merrill Lynch and to few other transactions. Do you think that this litigation is something that's going to continue to be a problem or is it really we're just seeing the tail ends of it now?

Sinegal: I think it's going to continue to be problem for a while. There are still a lot of unresolved issues. Bank of America, obviously, has the most. In addition, to the representations and warranties, there are some other claims against the bank, such as fraud and things like that dating back to precrisis.

We also so Wells Fargo get hit with a suit over FHA loans. So even the better banks are not immune. I think there are a lot of people still trying to recover lost investments from the days of the financial crisis. I don't expect to see those expenses coming down anytime soon.

Glaser: How about credit quality? Any trends this quarter?

Sinegal: Yes, credit quality is definitely improving especially in the mortgage business. We had executives at both Well Fargo and Jamie Dimon at J.P. Morgan talking about perhaps a housing market turnaround.

So, we're seeing delinquencies come down. There are plenty of signs of improvement in the housing market. That's definitely a positive. Additionally, obviously refinancing volumes remain strong in the low-interest-rate environment. Banks are benefiting, not only from the Home Affordable Refinance Program, but also just from people taking advantage of low rates to get a lower payment.

Glaser: So litigation risk is still there, but housing is getting better. What does that mean for investors? Is this a good time to be buying these stocks?

Sinegal: You know banks have definitely run up a lot in the last few months. So I'll start off with that. That said they are still somewhat undervalued. If you look at Wells Fargo and J.P. Morgan they are still at 10 times or less current earnings, and there is lot of reasons to think that earnings will improve in the future. At some point, albeit perhaps a long time from now, interest rates are going to rise; that will help them out.

These unusual expenses related to mortgage-servicing litigation are going to come down, and the banks are taking a lot of costs out of their expense bases in other areas. So [the banks are at] reasonable multiples of current earnings. Revenues are going to go up; expenses are going to come down. So we think they're still a moderately good deal.

Glaser: Jim thanks for being with us today.

Sinegal: Thanks for having me.

Glaser: From Morningstar I am Jeremy Glaser.