US Banks Expected to Report Increase in Loan Losses Amid Rising Interest Rates

This week, the largest banks in the United States are set to report a significant jump in loan losses, marking the largest increase since the beginning of the COVID-19 pandemic. The rise in interest rates has put mounting pressure on borrowers across the economy, leading to a surge in defaults.

While higher interest rates have provided some benefits to banks by boosting lending and investment income, the negative effects of inflation and increased rates are now being felt by lenders.

According to average estimates compiled by Bloomberg, the nation's six largest banks, namely JPMorgan Chase, Bank of America, Citigroup, Wells Fargo, Goldman Sachs, and Morgan Stanley, are predicted to have written off a collective $5 billion tied to defaulted loans in the second quarter of this year. Additionally, these banks are expected to set aside an estimated additional $7.6 billion to cover potential loan losses, nearly double the figures from the same quarter last year. However, it is important to note that these figures remain below the peak levels observed at the onset of the pandemic.

One of the major contributors to the banks' concerns is credit card loans. JPMorgan is estimated to have experienced $1.1 billion in card loan charge-offs in the quarter, a significant increase from $600 million in the same period last year. Bank of America also faces a substantial portion of charge-offs stemming from credit card loans.

Commercial real estate (CRE) loans are another area of concern affecting banks' performance. As remote and hybrid work arrangements continue, property owners are facing reduced demand for office space, impacting CRE loans. Wells Fargo, the largest CRE lender among the major banks, recently announced an additional $1 billion provision to cover potential losses related to office buildings and underperforming properties.

Earnings from investment banking are also anticipated to take a hit. The banks' Wall Street and corporate advisory businesses are expected to report a decline in revenues this quarter due to the prolonged lack of deal-making activity, which has surpassed executives' expectations. Trading revenues, which experienced significant growth in recent years amid volatile financial markets, are also expected to slow down.

Despite the challenges, bank analysts suggest that the benefits of increased interest rates are likely to outweigh the negatives for most of the major banks. On average, analysts expect the six largest US banks to report a 6% year-on-year increase in earnings per share. These banks have been considered a safe haven for investors amidst liquidity concerns for regional banks and increased regulatory worries.

JPMorgan is expected to announce the largest percentage jump in loan losses compared to the same period last year when it reports its earnings on Friday. Analysts predict that the combined cost of loan charge-offs and new provisions for JPMorgan in the second quarter of this year will be $3.8 billion, a 120% increase from the $1.8 billion reported in the same quarter last year. Similarly, Wells Fargo and Bank of America are expected to see their combined loan losses more than double in the quarter, with Goldman Sachs, Morgan Stanley, and Citigroup also experiencing significant increases.

Kenneth Leon, a bank analyst at CFRA, anticipates that Bank of America, Citigroup, and JPMorgan will increase their reserves to cover potential losses in commercial real estate this quarter. While banks have the option to work out problem loans, certain individual office buildings may present challenges for resolution.

The earnings reports from JPMorgan, Citigroup, and Wells Fargo are scheduled for Friday, followed by Bank of America and Morgan Stanley on July 18, and Goldman Sachs on July 19. Although the US banking sector endured a crisis in its regional banking system earlier this year, stress test results from the Federal Reserve indicated that the largest banks could withstand billions of dollars in losses and still have more capital than required by regulators.

While smaller banks have been offering higher savings rates to retain customers, larger institutions have maintained relatively modest interest rates for savers, thus boosting their profit margins.

However, analysts anticipate that larger banks will eventually have to improve their rates as well. "In the third and fourth quarter, the banks received a windfall to net interest income that exceeded expectations. Now, they will have to give some of that back. The exact amount is unknown, but it is unlikely to be the majority," said Chris Kotowski, a research analyst at Oppenheimer.

Overall, the second-quarter results are expected to highlight the challenges faced by US banks due to rising interest rates and increasing loan losses. However, analysts remain cautiously optimistic about the sector's performance, considering the potential benefits of higher interest rates.

By fLEXI tEAM