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RED FLAGS

The biggest US banks have some bad news about the American economy

John Detrixhe
By John Detrixhe

Future of finance reporter

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First the good news: The biggest US banks have had time to brace themselves for a wave of losses.

The bad news: They are still bracing themselves to withstand a wave of losses. Their earnings this week suggest the worst is yet to come for the American economy, and that Washington may need to provide even more support for workers and businesses.

Six of the biggest lenders all expect heavy credit defaults and soured loans, as shown by their loan loss provisions, which jumped 43% from the already hair-raising totals in the first quarter to a combined $36 billion in the second quarter.

Loan loss provisions aren’t, as they sound like, a special pot of money set aside for when loans go bad. It’s more like the amount of money banks expect to lose on their loans; it demonstrates the losses their capital may have to absorb in the months ahead and is subtracted from their earnings.

Approaching the moment of truth

For now the dire picture is merely a forecast.

Four months after lockdowns started smothering the world’s largest economy, bank losses have barely ticked up. JPMorgan Chase, for example, reports that charge-offs in its consumer business are little changed from a year ago.

Meanwhile, banks with powerful trading desks profited as stock prices gyrated and companies flooded the bond market with borrowing. JPMorgan said its markets unit had a record $9.7 billion of revenue, a 79% increase from 2019. Morgan Stanley had record profit, while Goldman Sachs said its fixed-income, currency, and commodities division had more than $4 billion of sales, its best quarter in nine years.

The big consumer lenders have yet to be battered by defaults and missed payments because of a ferocious wave of government support—including more than $2 trillion of aid to businesses and the unemployed—and because the banks themselves have offered forbearance and paused loan repayments for some of their customers. Bank of America said it has handled around $30 billion of requests for loan payment deferrals since the crisis set in, and that those requests have fallen by 98% since they peaked in April.

“You look at the banks and they are preparing of Armageddon and nothing is going wrong yet,” says David Ellison, a portfolio manager at Hennessy Funds. He’s optimistic the lenders can work through heavy credit losses—they got a lot of practice in 2009—but they will still have to contend with low interest rates, which makes their bread-and-butter lending businesses less profitable. They also increasingly have to compete with private equity firms that often target the same commercial clients.

If the government doesn’t agree on ways to continue supporting the economy as the initial relief programs expire, “things could start to fall off” for the banks, Ellison says. “And that’s where the banks are saying, ‘If that happens I have to be prepared for it.'”

JPMorgan Chase added $6.8 billion to its credit reserves and is more pessimistic about the economic downturn than it was three months ago. It expects heavy losses in the coming months that extend into 2021. “May and June will prove to be the easy bumps in terms of this recovery,” CFO Jennifer Piepszak said in an earnings call this week. ”And now we’re really hitting the moment of truth, I think, in the months ahead.”

Bank of America’s top executive expects the recession to extend “deep into 2022.” On an earnings call today (July 16), CEO Brian Moynihan said the lender expects US unemployment to end the year at 10% before gradually declining to 7.5% in 2021.

Wells Fargo, Citi

Not quite everything is gloomy. Wells Fargo CEO Charles Scharf said debit card spending made it back to pre-Covid levels in May; in the last week of June, debit card spending was up 10% from a year ago. But credit card spending remained subdued, some 10% lower in June from a year ago. Transactions using commercial cards were even weaker, down 30% during the last week of June, he said.

Citigroup’s CEO thinks the economy will only limp forward until a vaccine is available. “Normalization to me is, am I willing to get on the airliner, am I willing to get in a subway, am I willing to go into a crowded venue to watch a sporting event or a concert or what it may be,” Citigroup chief Michael Corbat said this week in an earnings call. “And I think realistically, when we get to that third bucket, I just don’t see that coming. And I would say many don’t see that coming until we feel like there’s an antivirus vaccine that’s available for the mass population around that.”

In the meantime, the carnage is expected to be widespread. Banks around the world are forecast to have more than $2 trillion in credit losses through 2021, according to analysts at Standard & Poor’s. Some $1.3 trillion of those losses are anticipated to come this year, more than double that of 2019.

“The unprecedented level of fiscal support that many governments across the world have deployed in response to the pandemic-related slowdown has been a key factor in supporting their citizens and economies during lockdown periods,” the S&P analysts wrote. “Perhaps the greater danger at this time is the reduction of such support too early, resulting in a longer and deeper economic contraction.”

It’s not clear that officials in Washington, having already committed trillions of dollars, are ready to spend even more. Beefed-up unemployment benefits have been a key plank of America’s response to the crisis, providing an extra $600 a week to workers who qualify. That program will fade away at the end of July unless politicians agree on a way to extend the aid. The government also dished out half a trillion dollars of loans through the Small Business Administration (SBA) to keep businesses afloat—a program that was built on the fly and riddled with inefficiencies but is widely credited with helping to keep the economy afloat.

Karen Mills, who ran the SBA during the Obama presidency, says more money is urgently needed for small enterprises. She forecasts that as many as 30% of these little operators are at risk of closing their doors for good. “We know already there are a number of businesses on the edge,” she said. “The next tranche of funding from the government is critical.”

Critical to small businesses, certainly. And also important for their banks.

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