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A buildup of bad debt threatens to dampen investors' growing optimism about the prospects for the largest U.S. banks when they report fourth-quarter results this week.
Non-performing loans – debt tied to borrowers who have not made a payment in the last 90 days – are expected to rise 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 consensus of Bloomberg analysts. That's almost $6 billion more than at the end of 2022.
Analysts expect banks' earnings to have fallen in the final three months of 2023, reflecting unpaid loans as well as the ongoing impact of higher interest rates that have increased the cost of deposits. Additionally, several major banks announced in December that they planned to charge a one-time fee by year's end to fund a special assessment by the Federal Deposit Insurance Corporation to cover $18.5 billion in defaulted loans last year To offset Silicon Valley Bank and Signature costs the regulator's insurance fund.
Cost reductions also continue. Citigroup, which is in the midst of its biggest restructuring in years, is likely to charge a fee to cover layoffs and other related costs. Wells Fargo said last month that it was setting aside $1 billion for severance costs in the fourth quarter.
Overall, the revenues of the six major banks, which include Goldman Sachs and Morgan Stanley, are expected to have fallen by an average of 13 percent in the last three months of 2023 compared to the same period last year.
“Forecasts for the coming year will receive a lot of attention during fourth-quarter earnings releases,” said Jason Goldberg, an analyst at Barclays. “I expect banks to signal that the recent decline in net interest income will bottom out this year.”
Despite the expected drop in profits, investors have been buying up bank stocks, which have risen 20 percent since the end of October, according to the KBW Nasdaq Bank Index. The rally is fueled by the Federal Reserve's signal late last year that it was probably done raising interest rates. Higher interest rates will hit banks in 2023, leading to higher deposit costs and a lower value of their bond portfolios.
“Banks are very interest rate focused,” said Matt Anderson, a banking analyst at commercial real estate research firm Trepp. “And investors are optimistic about the economy in 2024.”
But even if interest rate pressures ease, a rise in unpaid loans could continue to weigh on banks' profits.
The current level of non-performing loans is still below the peak of $30 billion during the pandemic. Major banks have indicated they expect the rise in unpaid debts to slow. A number of banks cut reserves for future bad loans, known as reserves, in the third quarter.
Provisions are likely to have fallen again in the last three months of the year. But if the amount of money banks are setting aside for bad loans unexpectedly increases, that could trigger alarm among investors.
“Credit is still a wild card,” said Scott Siefers, banking analyst at Piper Sandler. “It was very good, but I think we will see further deterioration from here.”
Commercial real estate, and particularly mortgages on less-used office buildings, was one of the biggest factors in the rise in problem debt.
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Recently, however, consumer loan defaults have increased, particularly on credit cards and auto loans. That has made some analysts nervous, particularly because banks' reserves for loan losses are now significantly lower than what they were when bad loans mounted at the start of the pandemic.
“Bank reserves are adequate right now because we are nowhere near the stress levels we had back then,” said Gerard Cassidy, banking analyst at RBC Capital Markets. “But do they have enough reserves for an economic hard landing? The answer is no.”
BofA, Citi, JPMorgan and Wells will become the first major banks to report their results for the final three months of 2023 on January 12.
Goldman Sachs and Morgan Stanley, whose businesses focus more on investment banking, trading and asset management, report results on January 16.
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