As the big banks unveiled second-quarter earnings, investors heard a common refrain: “we’re increasing provisions for client loan defaults.” While bank executives said these were just logical precautions for uncertain times, some investors saw them as hazard signals.
Citigroup Inc., JPMorgan Chase & Co. and Wells Fargo & Co. all increased their provisions for credit losses for the first time since the height of the pandemic. The accounting changes suggest elevated concern that borrowers may soon not be able to pay back their debts.
Bank of America Corp.’s provisions also rose after it made fewer reserve releases -- a measure where banks free up some of their reserves set aside for bad loans -- in this quarter than in the same period a year earlier.
Some bank executives sought to reassure traders that the loss provisions did not mean a recession was imminent.
“The US economy continues to grow” with both the job market and consumer spending remaining healthy Jamie Dimon, JPMorgan’s chairman and chief executive officer said in a statement last week, though he added that central bank rate hikes and geopolitical constraints on commodities are likely to have “negative consequences on the global economy sometime down the road.”
Goldman Sachs Group Inc., which provided for credit losses of US$667 million ($928.56 million) in the second quarter, attributed the shift to the simple fact there were more consumers borrowing.
“As long as interest rates increase and incomes in real terms go down, you will see an increase in leverage, you’ll see an increase in borrowing from households, and as that happens you’ll likely to see more defaults,” Maria Vassalou, co-chief investment officer of multi-asset solutions at Goldman, said in an interview. She added that while a reduction in consumption could lead to “a relatively shallow recession,” questions remained as to “how prolonged it’s going it be.”
But the consumer spending raised red flags for Matt Maley, chief market strategist at Miller Tabak + Co.
“Credit card debt is now above US$900 billion -- an all-time high -- and revolving debt, which of course includes credit card debt, is US$1.4 trillion,” Maley said. With real earnings coming down, “the only reason why consumer spending is holding up is because people are going further into debt to do it. And that can’t last forever.”
Here’s what others on Wall Street were saying:
Shawn Cruz, head trading strategist at TD Ameritrade Inc.:
“If you look at loan reserves as a percentage of loans outstanding, it’s more or less in-line with what we’ve seen or what we would expect to see for a loan book of that size.”
“If all of a sudden they start saying, ‘look, a lot more of these loans that we have out there are going to start seeing some trouble or becoming a little bit more uncertain as a percentage of the overall book,’ that would be, I think, a little bit more of a warning sign. But for now they’re not seeing any flashing warning signs that there’s a huge reckoning coming for the credit market.”
Fiona Cincotta, senior financial markets analyst at City Index Ltd:
“When they increase bad loan reserves, it’s because they’re fearing that companies, people, clients, are not going to be able to return the money that is being loaned to them.
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“This is just another warning signal that we are seeing, that the markets are reading into that we need to be concerned about a recession in the coming months.”
Art Hogan, chief market strategist at B. Riley:
“It’s likely a positive move in this environment. It’s taking some more insurance out in case there’s some larger loan losses that they will need to reserve for. It makes sense. If in fact the storm clouds turned into a hurricane, then they’ll likely need to have higher reserves to make it through the storm.”
“All the major banks have become overcapitalized on purpose. And that’s a feature, not a bug of the new regulatory environment that they live in. But I would say after the first quarter of this year, and the stress test they just went through, the majority of banks are going from, call it an average of about 10% of assets to 12%. So while that doesn’t sound like a lot, it takes away that additional money that they could otherwise be putting to work.”
Kim Forrest, founder and chief investment officer at Bokeh Capital Partners:
“The broader economy is certainly under stress, especially companies like JPMorgan that have a large credit card base.
“This increase is the correct thing to do. I also think companies that serve a middle market and smaller companies probably should take reserves for losses. Although they’re not saying much right now, it looks like we’re going to have two quarters of GDP decline. And it’s a pretty good bet that some of that debt won’t be repaid in a timely way.”
Chuck Cumello, president and chief executive officer of Essex Financial Services:
“Increasing provision for credit losses is being conservative in their estimates. They’d rather be ahead of it and release the reserves later and have it be a positive than be overly optimistic and all of a sudden have to surprise by setting money aside.”
“The fact is that you have some doing it, some not doing it -- Citi said they don’t see any indications of a recession. So it’s all over the map right now. That whole level of uncertainty is one of the key things driving this market. It’s why you’re seeing this tremendous volatility.”