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A pile-up of bad debt threatens to sour investors’ growing optimism about the prospects for the US’s largest banks when they report fourth-quarter earnings this week.
Non-performing loans — debt tied to borrowers who have not made a payment in at least the past 90 days — are expected to have risen to a combined $24.4bn in the last three months of 2023 at the four largest US lenders — JPMorgan Chase, Bank of America, Wells Fargo and Citigroup, according to a Bloomberg analysts’ consensus. That is up nearly $6bn since the end of 2022.
The analysts estimate bank earnings shrunk in the final three months of 2023, dragged down by those unpaid loans as well as the lingering impact of higher interest rates, which has raised the cost of deposits. In addition, in December, a number of big banks said they planned to take a one-time charge by the end of the year to pay for a special assessment being imposed by the Federal Deposit Insurance Corporation to recover the $18.5bn last year’s failures of Silicon Valley Bank and Signature cost the regulator’s insurance fund.
Cost-cutting also continues. Citigroup, which is in the middle of its largest reorganisation in years, is likely to take a charge to cover lay-offs and other related expenses. Wells Fargo last month said it was setting aside $1bn for severance costs in the fourth quarter.
In all, earnings at the six big banks, which includes Goldman Sachs and Morgan Stanley, are forecast to have dropped an average of 13 per cent in the last three months of 2023 compared with the same period a year earlier.
“Year-ahead outlooks get a lot of attention in fourth-quarter earnings calls,” said Jason Goldberg, an analyst at Barclays. “I’m expecting that banks will indicate that the recent drop in net interest income will hit its trough this year.”
Despite the expected earnings drop, investors have been buying up bank shares, which have risen 20 per cent since the end of October, according to the KBW Nasdaq Bank index. Fuelling the rally is the Federal Reserve’s signal late last year that it is probably done raising interest rates. Higher rates hit banks in 2023, raising deposit costs and lowering the value of their bond portfolios.
“Banks are very interest rate-driven,” said Matt Anderson, a banking industry analyst at commercial property research group Trepp. “And investors have an optimistic read on the economy in 2024.”
But even as interest rate pressures are easing, a jump in unpaid loans could continue to hold down bank profits.
The current level of non-performing loans is still below the $30bn peak of the pandemic. The big banks have indicated they think the rise in unpaid debts could slow soon. A number of banks cut the amount of money they put away for future bad loans, so-called provisions, in the third quarter.
Provisions are expected to have shrunk again in the final three months of the year. But if the money that banks are putting away for bad loans unexpectedly jumps, that could raise alarms for investors.
“Credit is still very much a wild card,” said Scott Siefers, a bank analyst at Piper Sandler. “It has been very good, but I think we are going to continue to see a deterioration from here.”
Commercial property, and in particular mortgages on less-full office buildings, had been one of the biggest factors pushing up problem debts.
More recently though, delinquencies have been rising on consumer loans, particularly credit cards and car debt. That has made some analysts nervous, especially because what the banks are putting away for loan-loss reserves now is considerably smaller than what they set aside when bad loans were rising at the start of the pandemic.
“Bank reserves are adequate right now because we are nowhere near the stress levels of back then,” said Gerard Cassidy, a bank analyst at RBC Capital Markets. “But have they reserved enough for an economic hard landing? The answer is no.”
BofA, Citi, JPMorgan and Wells will be the first of the large banks to disclose their results for the final three months of 2023 on January 12.
Goldman Sachs and Morgan Stanley, whose businesses skew more towards investment banking, trading and asset management, report results on January 16.