Increasing interest rates exert mounting pressure on borrowers while losses in the commercial real estate sector continue to accumulate.
Major banks are expected to report a significant increase in loan losses during the current week, marking the largest jump since the beginning of the COVID-19 pandemic. The rise in interest rates is adding mounting pressure on borrowers across various sectors of the economy.
While higher interest rates have benefited banks to some extent by boosting lending and investment income, the effects of increased rates and inflation are now becoming apparent. After a period of relatively low defaults due in part to pandemic-related stimulus measures and government assistance, lenders are beginning to observe the negative impact of higher rates on borrowers.
The country’s six largest banks, including JPMorgan Chase, Bank of America, Citigroup, Wells Fargo, Goldman Sachs, and Morgan Stanley, are projected to write off a combined $5 billion in defaulted loans during the second quarter of this year, according to average estimates compiled by Bloomberg from bank analysts’ predictions.
Trading Revenues and Interest Rates Shape Earnings Expectations
According to analysts’ estimates, the six major lenders are expected to allocate an additional $7.6 billion as provisions to account for potential loan defaults. These figures are nearly double compared to the same quarter of the previous year. However, they are still lower than the significant losses experienced by large banks during the early stages of the pandemic, where charge-offs and provisions reached $6 billion and $35 billion respectively.
Among the banks, credit cards are causing the most significant impact. JPMorgan is estimated to have incurred $1.1 billion in charge-offs for card loans during the quarter, up from $600 million in the same period last year. For Bank of America, credit card loans account for approximately a quarter of their charge-offs.
Trading revenues, which experienced a remarkable surge in recent years due to volatile financial markets, are anticipated to decelerate.
However, according to bank analysts, the advantages of higher interest rates are expected to outweigh the disadvantages for most major banks. On average, analysts predict that the six largest banks will report a 6 percent year-on-year increase in earnings per share.
Banks Serve as Investor Havens Amid Challenges and Loan Loss Projections
KBW bank analysts Christopher McGratty and David Konrad noted that these prominent banks have served as a reliable haven for investors amid concerns over liquidity in regional banks and heightened regulatory scrutiny. Nevertheless, they emphasized that universal banks still face challenges in the current environment.
JPMorgan, one of the first banks set to report on Friday, is anticipated to announce the most significant percentage increase in loan losses compared to the same period last year.
According to analysts’ predictions, the total expenses from loan charge-offs (unrecoverable losses) and new provisions for the second quarter of the year are estimated to be $3.8 billion. This represents a 120 percent surge compared to the $1.8 billion in losses from soured loans reported by the largest bank in the nation during the same quarter of the previous year.
Wells Fargo and Bank of America are expected to see their combined loan losses more than double in the quarter, while Goldman Sachs is projected to experience a 70 percent rise, and Morgan Stanley and Citigroup both forecasted a 60 percent increase.
Kenneth Leon, a bank analyst at CFRA, foresees that BofA, Citigroup, and JPMorgan will allocate additional reserves in order to cover potential losses in the commercial real estate sector for this quarter.
Banking Sector Faces Challenges and Earnings Reports
In a note to clients last month, Leon stated that as lenders, banks can always engage in loan workouts to address problematic loans. However, he acknowledged that certain individual office buildings may present challenges in finding solutions.
JPMorgan, Citigroup, and Wells Fargo are scheduled to report their earnings on Friday, followed by Bank of America and Morgan Stanley on July 18. Goldman Sachs will report its earnings on July 19.
The banking sector demonstrated resilience during a regional banking crisis earlier this year, as stress test results from the Federal Reserve indicated that the largest banks could withstand substantial losses and still maintain capital levels exceeding regulatory requirements.
While smaller banks have raised savings rates to retain customers, larger institutions have continued to offer relatively modest interest rates, thereby bolstering their profit margins.
However, analysts anticipate that larger banks will eventually need to enhance their rates.
“In the third and fourth quarter, banks experienced unexpectedly high net interest income, surpassing expectations. Now, they may have to relinquish some of those gains. The exact extent remains uncertain, but it is unlikely to be a majority,”.