NEW YORK — This is turning into a rough year for Wall Street banks.
On Thursday, with the market flat, financial stocks were among the weakest.
The industry is under pressure after lending billions to energy companies that are now grappling with falling oil prices and plummeting profits. A bet that the Federal Reserve would increase key interest rates several times this year — allowing the banks to increase their profits margins — is also turning bad. And investors have grown concerned that if weak economic growth overseas continues to weigh on European banks, the fallout could seep onto the balance sheets of their U.S. counterparts.
It is Wall Street’s biggest challenge in years and a potential test of whether reforms put in place after the 2008 financial crisis are strong enough to withstand new market pressure.
This comes as Wall Street has become a punching bag in the 2016 presidential election. Democratic candidate Bernie Sanders often rallies his supporters with calls to break up the big banks.
“There is no doubt that the rise of populism in the Presidential race is creating further market uncertainty,” activist investor Dan Loeb told his investors in a letter recently. “The 2015 market we dubbed a ‘Haunted House’ feels about as scary as the Disney kids’ ride ‘It’s a Small World’ when compared to 2016.” (Loeb’s hedge fund, Third Point, has a $14 billion portfolio.)
Earlier this week, Neel Kashkari, who managed the $700 billion Troubled Asset Relief Program used to rescue banks during the crisis, piled on. “The biggest banks are still too big to fail and continue to pose a significant risk to our economy,” Kashkari, who is now president of the Federal Reserve Bank of Minneapolis, said in a speech at the Brookings Institution. Kashkari, a former Goldman Sachs banker, said the bank would issue proposals by the end of the year to prevent another financial crisis.
Any such proposals would likely face an uphill battle in a Republican-led Congress, which has made rolling back financial reform a priority. And industry analysts note that banks have much more capital and are much better prepared for financial turmoil than they were in 2008. More regulations, they say, would suppress the risk-taking that makes Wall Street the center of the financial world.
“The Fed’s stress tests show that large financial institutions can withstand a crisis far worse than 2008, and the largest banks have ‘living wills’ to guide an orderly wind-down without putting taxpayer money at risk,” said John Dearie, acting chief executive of the Financial Services Forum, an industry group.
Much of the industry’s current troubles can be traced to low interest rates. The Federal Reserve kept rates low for seven years before raising them modestly in December and indicating that rates would be raised again several times in 2016. With higher interest rates, banks would be able to charge more for their loans and secure bigger profits.
But in the face of market volatility and global economic weakness, those potential interest rates hikes appear less likely. And U.S. banks, already weathering one of the most volatile starts to the trading year in history, can no longer forward to fatter profits from increased rates, analysts said.
“The fear is that low interest rates could be here indefinitely,” said Erik M. Oja, banking analyst for the market research firm S&P Capital IQ.
Investors have also become concerned about the billions Wall Street lent to into oil and gas companies over the last few years. The industry is faltering as a glut of crude drives down prices and sends dozens of energy companies into bankruptcy. The number of energy sector bankruptcies during this downturn could surpass the level reached during the financial crisis, according to Deloitte, the auditing and consulting firm.
But even these concerns may be overblown, analysts say. Despite significant growth over the last few years, energy sector loans still comprise a small part of the industry’s balance sheet, analysts say. About 2 percent of outstanding U.S. bank loans have are with energy companies, according to S&P Captial IQ.
Still, some banks have begun setting aside more money to cover potential energy sector losses. Citigroup set aside $588 million to deal with loan losses during its fourth quarter, about half of which it expects to go towards the energy sector.
Financial reform requirements mean that banks have larger financial cushions to withstand heavy losses on loans to the energy sector, analysts say. “Of course, should oil prices fall to $20 [per barrel] and stay there for an extended period, which we don’t foresee, then the story changes for the worse,” Oja said.
Even if Wall Street is prepared to withstand weakness in the U.S. economy, falling oil prices, or low interest rates, analysts say, the bigger threat may lay overseas. European banking giants Deutsche Bank and Credit Suisse recently reported their first full-year loss since the financial crisis, sending their stock prices down 25 percent and 36 percent respectively so far this year.
Both banks have been saddled with billions in charges related to legal settlements and are still restructuring to reflect a post-financial crisis regulatory environment, analysts said.
“The U.S. banking sector adjusted faster, earlier and more successfully,” said Brian Lawson, economic and financial consultant for IHS, the research firm.
That pain could be exacerbated by weakness in the economies of some European countries, analysts said. Some countries, including Switzerland, Denmark and Sweden have resorted to negative interest rates, forcing investors to pay to save money rather than earning positive interest. That practice also compresses bank profits, analysts say.
In a report Wednesday, Morgan Stanley analysts called negative interest rates a “dangerous experiment” that could erode bank profits 5 percent to 10 percent.
“We do not think that a major credit event is likely in Europe. However, worries over European banks impact global financial markets, including leading US firms, because the financial system is all interlinked,” Lawson said. “This is not another Lehman like moment, but the market has treated it as it were.”
U.S. banking executives say that despite the recent turmoil, their balance sheets are fundamentally strong. Morgan Stanley has announced a plan for improving profitability. “Our entire focus is on driving results,” James Gorman, the company’s chief executive, told analysts last month. “We enter 2016 with a continued focus on managing expenses across the firm and driving up returns for our shareholders.”
