US Banks Brace for Economic Headwinds
In the ongoing cycle of monetary tightening by the Federal Reserve (the Fed) and the looming threat of a US recession in the later part of this year or 2024, American banks consistently set aside larger provisions to address potential loan losses. Despite reporting robust earnings in the second quarter, major banks have expressed concerns about the impact of rising interest rates on borrowers, mainly as government-backed measures supporting households and businesses during the pandemic are set to expire.
S&P Global Market Intelligence reveals that loan loss provisions (LLPs) have increased at nearly two-thirds of the analyzed financial institutions, with major banks like Bank of America and Citibank allocating significant amounts to cover potential losses. While reporting solid earnings, JPMorgan Chase has also set aside substantial provisions, emphasizing the challenges ahead as the US economy is expected to slow.
Even smaller banks, like Sandy Spring Bancorp and SouthState Corp., are witnessing increased provisions, reflecting the broader trend of concerns about potential loan defaults. Commercial real estate, especially offices, is identified as a problematic sector for bad loans, with higher borrowing costs and lower demand exacerbating the situation. Some office owners are reportedly defaulting on loans, adding to the uncertainties in the market.
US banks, notably Wells Fargo, are cautious about their exposure to commercial real estate, and a significant portion of Wells Fargo's outstanding commercial property loans involves offices. The anticipation of a rise in soured loans is evident in the growing number of corporate debt defaults, surpassing the total for the previous year. Moody's Investors Service predicts a substantial increase in corporate debt defaults, and Deutsche Bank suggests that US loan defaults could approach levels seen during the 2008 Global Financial Crisis.
Looking ahead, the credit environment is expected to become even more challenging, with the likelihood of a pronounced recession. Moody's has downgraded the credit ratings of several banks, expressing concerns about a potential tightening of credit conditions and rising loan losses. Interest-rate and asset-liability management risks and profitability pressures further contribute to the complex landscape for US banks, especially as unconventional monetary policy winds down and a mild recession is anticipated in early 2024.
Despite these challenges, the prevailing sentiment is that the positives derived from higher interest rates, particularly in net interest margins, still outweigh the higher loan losses banks are currently allocating for. While larger banks are seen as a relative haven for investors amid liquidity concerns and increased regulations, the overall environment remains challenging for universal banks.