US banks to set aside $4bn for potential losses from bad loans

The biggest US banks will signal their worries about the US economy in third-quarter earnings reports starting next week, with analysts expecting they will set aside more than $4bn to cover potential losses from bad loans.

The anticipated provisions will be far smaller than the ones made by lenders at the start of the pandemic in 2020, when they increased reserves by tens of billions of dollars to brace themselves for an economic shock that was largely avoided thanks to unprecedented monetary and fiscal stimulus.

Now, with loan demand still growing, banks are preparing for the possibility that rising interest rates will slow the economy and result in higher credit losses — a concern that has already dented bank stock prices this year.

“The overall economic outlook has deteriorated somewhat and therefore it would be natural to expect some incremental pick-up in bank reserving actions,” said Ken Usdin, banking analyst at Jefferies.

“At this point, there’s not a very high expectation for losses to kick up in an immediate sense. But the bigger question is what does the economy look like over the course of the next year to 18 months.”

The six largest US banks by assets — JPMorgan Chase, Bank of America, Citigroup, Goldman Sachs, Wells Fargo and Morgan Stanley — will collectively provision about $4.5bn in loan-loss reserves in third-quarter earnings, according to analysts’ estimates compiled by Bloomberg. It would be the third consecutive quarter of loan-loss provisions by the banks.

Investors will also be looking to see whether banks mark losses on loans for leveraged buyouts that they have committed to financing but have not yet been able to sell to third parties. In the second quarter, banks took hundreds of millions of dollars in mark-to-market losses.

JPMorgan, Morgan Stanley, Citi and Wells Fargo will disclose earnings on October 14, followed by BofA on October 17 and Goldman the next day.

The KBW Bank Index is down around 22 per cent in 2022, compared with a roughly 20 per cent decline in the benchmark S&P 500 index. The fall reflects concerns that more loans will sour, even as rising interest rates help lenders boost net interest income — the difference between what banks pay for deposits and what they earn from loans and other assets.

“Bank stock investors, a group never prone to ‘enjoying the moment’, are already looking through” good news and are “worrying that we’re getting close to peak earnings”, wrote analysts at Autonomous Research.

Bank executives have said US credit quality remains excellent with defaults tracking well below historical norms, and companies and customers still sitting on cash accumulated during the pandemic.

At an industry conference last month, JPMorgan president Daniel Pinto said: “The consumer here in the United States is in a very, very good place.”

Analysts also say big US banks — following stress tests organised by the Federal Reserve and new capital requirements — are well-positioned to weather an economic downturn.

“Banks enter this period of uncertainty in a position of strength,” said Jason Goldberg, banking analyst at Barclays.

Under a methodology put in place in 2020 — called current expected credit losses, or “Cecl” — banks are required to set reserves in good times so they have sufficient capital buffers when losses occur.

“The difference in the outlook for the economy from the end of June, compared to the end of September has clearly weakened. And therefore according to Cecl, reserve building has to go up,” said Gerard Cassidy, of RBC Capital Markets.

Analysts anticipate that earnings per share across the six leading banks will decline on average about 22 per cent in the quarter.

Third-quarter revenues at JPMorgan, BofA, Citi and Wells are expected to rise year on year by about 4 per cent, benefiting from higher net interest income.

Goldman and Morgan Stanley, which derive a greater share of earnings from investment banking, are expected to see revenues fall because of slower dealmaking activity.

“Traditional investment banking is very weak. Equity capital markets are down fairly significantly,” said Christian Bolu, an Autonomous Research analyst.

The declines will sharpen the focus on banks’ management of expenses and headcounts.

Banks’ stock and bond trading divisions — on the back of volatile markets — are expected to continue their strong performance in the third quarter.

“Trading, generally speaking, should be up modestly from the third quarter of last year, which was a particularly strong quarter,” Barclays’ Goldberg said.

Additional reporting by Imani Moise