Bank stocks are on a tough run.
In a recent note to clients, Deutsche Bank’s Matt O’Connor pointed out that the KBW Nasdaq bank index is down 17% from its highs in July last year. It’s down 15% since early December, and 9% so far this year.
There are a lot of questions circling, including what to expect going forward in 2016.
O’Connor pointed to two potential downside risks for banks this year.
Higher credit costs
O’Connor and his team expect a 10 basis point increase in “loan loss provision expenses” — that is, expenses put aside to cover bad loans that customers default on or need to renegotiate.
That doesn’t bode well for bank earnings. According to the note, every 10 bp increase in loan loss provision expenses this year will translate into about a 4% drop in overall earnings.
Weaker markets revenues
One of the biggest things to hurt bank earnings last year was a drop in trading revenues. But O’Connor says we’re less likely to see a similarly outsized drop this year, thanks to a sharp reduction in inventory and the fact that traders are taking fewer risks.
That said, any macroeconomic weakness will still hurt bank earnings, in O’Connor’s view. He estimates a potential earnings drop of 7-10% for Bank of America, Citigroup, and JPMorgan, and a 25% drop at Goldman Sachs and Morgan Stanley.
That estimate is based on a 10% cut in investment banking and trading fees, a 20% cut to private equity and investment revenue, and a 5% cut to wealth management, asset management, and brokerage fees.
That sounds pretty bad, but remember, downside risk is a worst-case scenario estimate.