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Financials: Goldman's Absolution Is a Big Milestone for Big Banks

By Alex Dumortier, CFA - Apr 12, 2016 at 11:47AM

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Goldman Sachs' $5 billion settlement related to mortgage-backed securities is a milestone for the banking sector in the wake of the credit crisis.

200 West Street, Goldman Sachs's headquarters in lower Manhattan. Image source: edenpictures, republished under CC BY 2.0.

U.S. stocks are higher in late morning trading on Tuesday, with the S&P 500 (^GSPC -4.04%) and the Dow Jones Industrial Average (^DJI -3.57%) (DJINDICES: $INDU) up 0.73% and 0.85%, respectively, at 11:35 a.m. ET. As this column noted yesterday, market-watchers will be tracking Financials closely this week, with three of the four largest weightings in the sector announcing first-quarter earnings: Tomorrow morning, JPMorgan Chase & Co. reports, followed by Bank of America Corp and Wells Fargo & Co (both on Thursday morning).

(If you're wondering, the top-weighted financial company in the S&P 500 is actually conglomerate Berkshire Hathaway.)

The sector outperformed yesterday, with the Financial Select SPDR ETF gaining 0.4%, even as the S&P 500 fell 0.3%. One major contributor to that outperformance was Goldman Sachs & Co., shares of which were up 1.3% as the investment bank announced that it had reached a $5 billion settlement with federal and state authorities relating to the mis-selling of mortgage-backed securities in the run-up to the global financial crisis.

This Fool thinks the announcement has a symbolic value in that it draws the line on billion-dollar-plus fines and settlements related to the credit crisis. In February, Wells Fargo & Co and Morgan Stanley reached settlements of $1.2 billion and $3.2 billion, respectively. Last month, The Wall Street Journal reported [sign-up may be required] that large U.S. banks had paid $110 billion in mortgage-related fines.

Indeed, the terms of the definitive agreement Goldman announced yesterday "are substantially the same as those announced on January 14, 2016, with respect to an agreement in principle."

Naturally, the terms of an agreement in principle can change (or the agreement can collapse altogether), but I don't think that's enough to explain Goldman's outperformance.

This agreement is a milestone on the path of the banking sector's return to grace (with investors, I should add -- not the general public!). That process of absolution is ongoing; expect the valuation of some of the top banks to normalize further, as my Foolish colleague John Maxfield argued yesterday.

Despite yesterday's lift, Goldman's shares continue to trade at an 11% discount to their book value, according to data from Bloomberg.

No wonder the market is wary: Banks are always involved -- if not at the center of -- pretty well every boom-and-bust cycle (it's a leverage thing), the latest one being energy and commodities, of course. This morning, Bloomberg published an in-depth article asserting that Wells Fargo misjudged the risks of energy financing.

That's surprising for Warren Buffett's favorite large bank, which has a reputation as a smart, conservative lender. Analysts and investors will undoubtedly want to probe this area with Wells' management come Thursday morning.

As noted yesterday, Energy and Financials are the two S&P 500 sectors that are expected to experience the largest year-over-year drop in operating earnings in the first quarter.

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