Credit Costs to Outweigh Margin Gains

Banks will lose between $57 billion and $137 billion during the year due to rising loan defaults, Miller wrote. Including replenishing loan-loss reserves to cover future losses, banks will have to set aside between $80 billion and $185 billion in 2008, Miller said.

Miller anticipates banks will face rising charge-offs, or loans written off as not being repaid, which will push credit costs higher. Miller said defaults are likely to rise across all types of loans, from mortgages to consumer and construction loans.

Those losses will outweigh any benefits of recent Fed rate cuts. The Fed cut the federal funds rate by 1.25 percent over a period of eight days in January. The current rate of 3 percent should enable banks to increase their interest margin the spread between how much it costs banks to borrow money and how much they receive from lending money to customers.

Based on past rate cut cycles and recent interest margins, Miller projects 2008 average net interest margin at banks will range between 3.1 percent and 3.5 percent, up from 2.92 percent during the 2007 fourth quarter.

Using the midpoint of that range, Miller said net interest income would increase by $36 billion during the year, well short of even the low end of credit cost projections.

The difference between rising credit costs and net interest margin will likely reduce banks' earnings by 30 percent in 2008, Miller said.