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Financial Services: 5 Years After Lehman

Jeremy Glaser
Jim Sinegal

Jeremy Glaser: For Morningstar, I'm Jeremy Glaser.

It's been five years since the Lehman Brother bankruptcy shook up the financial-services sector and the global economy. I'm here with Jim Sinegal, our director of financial-services research, to take a look back at the Lehman bankruptcy and also how the sector has changed over the last half decade.

Jim, thanks for joining me today.

Jim Sinegal: Always good to be here.

Glaser: Let's take a look back five years ago to understand exactly what happened with Lehman. What impact did it have immediately on the financial-services sector?

Sinegal: I think the Lehman bankruptcy, more so than the previous problems with Fannie and Freddie, really started that panic in the financial sector. I think the Lehman bankruptcy showed that no one was really safe in the financial crisis. Beforehand people thought that the subprime problems were isolated to maybe one or two firms. Lehman was really the start of the contagion, especially because they had a sizable derivatives business.

Glaser: With this crisis, what kind of actions did we see and how has that set the stage for the current investment landscape?

Sinegal: One of the things that we did well in the wake of the financial crisis was the government took actions fairly quickly. Not too long after Lehman, we drastically expanded the amount of emergency lending; firms like Goldman and Morgan Stanley became bank-holding companies and were able to take advantage of that. And really within six months of Lehman, TARP had been enacted, and we managed to recapitalize the financial system to a large extent. I think it's one thing we really did well in the United States.

Glaser: This really shook up the financial landscape. There were a lot of mergers, some forced, some not. When you look back at that, who has handled those mergers well? Who has really thrived in this post-Lehman environment, and who has had a lot more trouble?

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Sinegal: One of the firms that has done the best has been PNC, and that's not surprising, as even prior to the financial crisis they had a really good history of turning around troubled firms that they had acquired. They had done it with Riggs, with Sterling. National City was really the biggest deal they had done, but [PNC] was a firm that had shown prowess in really integrating and turning around firms with problems.

On the other hand, of course, you have companies like Bank of America. They paid too much for Countrywide, paid too much for Merrill, and in addition to that, they were saddled with, obviously, a ton of liabilities related to mistakes that Countrywide, especially, had made in the years leading up to the crisis.

Glaser: What kinds of differences have you seen between the reaction in the United States and how the U.S. financial firms reacted [compared] to those in Europe?

Sinegal: As I mentioned, the U.S. was able to act quickly and decisively, because really it was only a handful of people dealing with it. Paulson, Geithner, and Bernanke really worked together and worked in somewhat of a dictatorial fashion to get us out of the crisis and take action to recapitalize troubled firms.

I think when you look at Europe, and they are still dealing with their problems to some extent, not having one country and one set of regulators dealing with it, it really took them a long time to decide how they were going to recapitalize their banks, how they were going to lend, what they were going to do with the euro and money printing, and I think that's why the U.S. emerged much more quickly than Europe from the financial crisis.

Glaser: So, taking a look at the landscape today, could we see a repeat of 2008 again? Is the financial system still very unstable or have these actions from government and other entities really reduced a lot of that risk?

Sinegal: I think the possibility is always there, but I think it's a lot less likely--first of all, just because of the dramatic amounts of capital that have been injected into the financial system. At the depth of crisis, Citigroup was levered between 50 and 100 times on a tangible basis. Now the firm is levered 10 to 1. So it will take much bigger losses in order to cause problems of that nature.

And at the same time, a lot of the bad loans that were made in really optimistic times are off the books, and most of the banks' balance sheets now are really conservatively underwritten, because it's loans and securities that were purchased in 2009-2010, the depths of the recession. So although it could happen, I think it will be a long time coming.

I think the possibility, though, is always there in other countries. As long as there is a lot of leverage and not enough capital to support it … number one, that's a difficult measurement to take. How much capital does a bank need? I think people will always argue that … the possibility is there.

So, I think we're safe for the time being, but never completely safe when you're dealing with that much leverage.

Glaser: Thinking about the market then, do you see any attractive investments in financial services, or is this good news mostly priced in?

Sinegal: I think a lot of the good news is priced in. The sector as a whole is fairly valued. I mentioned PNC earlier, though, and that's one firm we think is somewhat undervalued right now. It's really well managed and trading at a slight discount to our fair value estimate. And Wells Fargo is another company we always like. I think there is some pressure on it due to the mortgage fall-off. Obviously, the mortgage market now is much slower than it was just six months ago. People are worried about that a little bit. But it's still a really well-run firm and one that's going to be returning capital in the forms of dividends and repurchases going forward.

Glaser: Jim, thanks for your thoughts on the crisis today.

Sinegal: Thanks for having me back.

Glaser: For Morningstar, I'm Jeremy Glaser.