Five Big Questions About Banks

Jason Stipp: I'm Jason Stipp for Morningstar and welcome to The Friday Five.

We're about two years on from the Lehman Brothers collapse and the depths of what is now known as "The Financial Crisis," and I wanted to check in on one of the major players in that crisis--the banks.

Here with me to offer some insight and answer five questions for us today on the banks is Jim Sinegal. He is associate director of equity research covering the banks. Thanks for joining me, Jim.

Jim Sinegal: Thanks for having me.

Stipp: So the first question for you I think is one that's very near and dear to the hearts of our readers on Morningstar.com, and it has to do with bank dividends. We saw unfortunately some dividends cut in the banking sector. I think a lot of folks are probably wondering when they will come back in full force, and when they do come back, can we think of them as being stable once again or must we think of them as a higher-risk dividend?

Sinegal: It's hard to know exactly when dividends will come back, but I think the short answer is it's going to be a while. We haven't gotten any clear guidance from regulators on what the new capital requirements are going to be and banks aren't sure how profitable they're going to be in the future. So if you're bank management, board of directors, you don't know how much capital you're going to have to hold, you don't know how much money you're going to be making. So it's really hard to decide at this point how much you're going to be able to pay out to shareholders.

When they do come back, I think they will be stable. I think people are going to be lot more conservative as far as payout ratios, how much of their income they're going to give out to shareholders. So I don't think we'll see dividend cuts until we get another crisis, which is hopefully at least a decade down the road.

Stipp: We'll knock on wood for that certainly.

One of the issues that the banks face, and the second question is [regarding] some of the big write-offs that they have to take for some of the bad loans, especially in the mortgage area. The write-offs seem to have gotten better in some areas but then there's still talk out there about another shoe to drop in commercial real estate and other loans that might be on the books. Have we seen the write-offs really stopped or have they just paused?

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Sinegal: I think we might have seen a pause or at least a tapering off in the pace of write-offs. A lot of the worst investments that were made earlier in the cycle are essential written down to zero at this point.

As far as commercial real estate goes, those losses are still rolling through, but the banks do have some leeway in deciding exactly when to take losses there.

As long as the economy is down, I think the pace of losses is going to continue at what we've seen in the last quarter or two. But I think a lot of the big surprises are out of the way.

Stipp: Well, that's certainly good news on that front. Another issue that sort of relates to the economy is the lending, or the lack of lending, that's happening at banks.

On one side you have some folks saying the banks really need to be out there lending more, but sometimes the folks at the banks are saying, "Hey we just don't have the demand. They aren't people that are asking for the loans."

What's the real story there? Is there lending going on? And if there isn't, why?

Sinegal: I think you are exactly right in that it depends on who you ask. There are a lot of borrowers that have gone to the banks and found that standards have really tightened over the past few years. And the banks on the other hand are blaming it on a lack of demand. They are saying that the people that come in just aren't good borrowers.

I think it's a little bit of both. The banks are still understandably cautious. Regulators are really enforcing a lot more than they were in the beginning of the crisis. They're a lot stricter as far as what the banks can do.

And on the other hand, I don't think a lot of people really want to take on additional debt now. Unemployment is still high. The economy is still in the doldrums. I think consumers and businesses seeing that are really reluctant to put on debt. And there is a lot of leftover debt from the boom years that needs to be worked off.

So I think it will be awhile before we see loan growth no matter whether it's a demand-side problem or a supply-side problem.

Stipp: So shifting the conversation a little bit and thinking about banks as a consumer thinks about them. We've been reading a lot about some of the recent regulations and the effects that that might have on bank consumers, so us as everyday bankers, and what kind of differences we might see in our bank accounts and our interactions with banks?

I think one of the big concerns is that we'll all be hit with a lot of extra fees. When you guys are looking at how the banks are planning to make money, given the new regulations, are fees a big part of that or what should we expect as consumers of bank services?

Sinegal: That's exactly right. I think a lot of people have thought the regulation is really going to hamper bank profitability. There's lot of new restrictions on what they can charge for certain items. But I think what people miss is that the regulations that affect all the banks equally make it a lot easier to pass on these costs to consumers.

For example, we've seen that with the CARD Act. Credit card companies were restricted in how often they can adjust rates, but the banks just went out ahead of time and raised rates on everyone proactively.

The same thing with overdraft fees. It's a lot harder now for banks to charge fees on people who overdraft. So, we're already starting to see the demise of free checking and the banks passing it on in that way. I think the takeaway is the banks aren't going to take this lying down, and consumers are going to end up paying a lot of these additional costs.

Stipp: So one way or another that same amount of money might end up leaving your wallet through one other fee or another fee that you were not paying before.

So, last question for you, Jim, from an investor's perspective. As I'm thinking about which banks look like they're best positioned moving forward in this new environment, an environment that maybe won't see as rapid a growth, but it might be more stable. There are certainly different regulations now.

Who is best positioned from the bank perspective to really outperform or to do well in that kind of environment?

Sinegal: I think in general the small to midsized banks are in better position, at least as far as regulation goes. To some extent it affects everyone, but it was really targeted at the biggest banks, the ones that cause the systemic risk. They are the ones that are going to see higher capital requirements, more restrictions. They're going to be more exposed to the new Consumer Protection Acts. And I think there is just a continued backlash against the larger banks. A lot of people want to take their deposit business, their lending business to the smaller banks. They want to get back to that relationship-based banking rather than just looking for the cheapest price. And I think some small and midsized banks are really going to benefit as far as that goes.

Stipp: Jim, thanks for joining me today. And thanks for your insights on these five burning bank questions.

Sinegal: Thanks, for having me.

Stipp: For Morningstar, I'm Jason Stipp. Thanks for watching.