Wall Street’s six biggest banks have set aside nearly $38bn to cover loans going bad – yet there are some grounds for optimism.
The numbers are truly breathtaking.
During the last three days, America’s six largest banks have set aside almost $38bn (£30bn) to cover loans which they now do not expect to be repaid, either in full or in part.
The biggest single provision came from JP Morgan Chase, the world’s biggest bank by stock market valuation, which set aside a record $10.5bn (£8.2bn) on Tuesday.
The same day saw Wells Fargo put aside $9.5bn (£7.4bn), pushing it to its first quarterly loss since 2008, while Citigroup set aside $7.9bn (£6.2bn).
They were followed on Wednesday by Goldman Sachs, which put by $4.4bn (£3.4bn), while today Bank of America – the second-largest US lender – set aside $5.5bn (£4.3bn).
Morgan Stanley, meanwhile, today made a loan loss provision of $239m (£187m).
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The provisions, announced as the banks reported results for the second quarter of the year, highlight how banks are battening down the hatches ahead of an expected rise in corporate collapses, unemployment and personal bankruptcies in the US following the COVID-19 pandemic.
The figures are ominous because banks are a good barometer of what is happening in the economies in which they operate.
When economies are thriving, banks flourish, but they suffer fall during economic downturns.
So the sheer size of these provisions may raise fears that a re-run of the financial crisis in 2008 is on the cards.
That does not appear to be the case presently.
A decade of prudent financial regulation means America’s lenders are much better capitalised than they were heading into the global financial crisis.
It does not mean Wall Street’s chieftains are not uneasy about the outlook.
Jamie Dimon, chief executive of JP Morgan Chase, said the bank was expecting a “much murkier economic environment going forward than in May or June”.
He added: “We are prepared for the worst case.
“We simply don’t know [how things will pan out]. I don’t think anyone knows.”
Charlie Scharf, the chief executive of Wells, was equally cautious.
He remarked that the size of his bank’s provisions reflected a change of view on “the length and severity of the economic downturn [which] has deteriorated considerably from the assumptions used last quarter”.
And things may get worse fairly soon.
The end of the month will see the end of the extra $600 (£470) a week the US government has been paying to Americans claiming unemployment benefits.
It may well be that the real carnage, in terms of customers missing mortgage and credit card payments, is yet to come and particularly because most lenders have been offering payment holidays.
Yet there are some grounds to feel cheerful.
The first is that the banks are in a position to be able to make these provisions without having to go to shareholders or worse, taxpayers, to bolster their balance sheet.
Most banks are sufficiently well-capitalised to be able to withstand expected loan losses of this magnitude.
As Mr Dimon put it: “We could bear another $20bn of loan loss reserves.
“That $20bn brings us to an extreme adverse [scenario] which roughly may equate to the U or W [shaped recovery].
“We’re going to do a lot more analysis on that because, obviously, we need to be prepared for that.”
A second point to make is that the accounting rules concerning loan loss provisions are tougher than they were during the financial crisis and its aftermath.
Previously, banks only needed to increase the reserves set aside to cover potential losses on loans when customers missed repayments.
But under the new regime – called ‘Current Expected Credit Losses’ (CECL) – banks must make provisions based on what they expect to happen over the lifetime of a loan.
If a loss is expected over the lifetime of that loan, provision for it must be made immediately, which is a more conservative approach.
A third issue is the approach of the banks themselves towards provisions for doubtful loans.
The banks have been walking a tightrope.
Take too aggressive an approach towards loan-loss provisions and they risk terrifying the public by indicating they expect a severe recession.
Take too tame an approach and they risk being accused by regulators and politicians of being too laid-back and not taking the economic impact of COVID-19 sufficiently seriously.
So you can be sure a lot of care and thought will have gone into these provisions.
It is also worth dwelling on the breakdown of the money set aside.
For example, given its comparative size, one might have expected Bank of America’s provisions to be higher.
The reason they are not is because the bank takes quite a cautious approach in the field of credit cards and turns away a lot of applications from potential borrowers it regards as insufficiently creditworthy.
Morgan Stanley’s provisions were so low, compared with its peers, because it has neither an SME (small and medium enterprise) lending arm nor a credit card business.
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The various activities in which the big six banks engage also explains why their profits have been affected in different ways by their loan loss provisions.
The volatility in markets this year has been a boon for those banks still with big capital markets or trading operations.
For example, Wells Fargo is much more of a player on Main Street than on Wall Street, so its comparatively small capital markets division was not enough to make up for expected big loan losses.
By contrast, JP Morgan’s problems in consumer and SME lending were partly compensated for by record trading revenues, with bond trading alone generating some $7.3bn (£5.7bn) worth of revenues.
To that end, the two big winners from this reporting season have been Morgan Stanley and Goldman Sachs.
The former reported a record quarterly profit today, with earnings rising by 45% to $3.2bn (£2.5bn), helped by a 68% rise in trading revenues.
Goldman, meanwhile, enjoyed its best trading quarter in a decade and profits that exceeded analyst expectations.
These developments represent a reverse of what has been seen during the last decade.
Following the financial crisis, US financial watchdogs tightened regulation of activities like trading, while a lack of volatility in markets also ensured they were less lucrative.
At the same time, with incomes rising and employment booming, it proved a profitable time for lenders exposed to Main Street.
In response, institutions like Goldman have sought to become more bank-like, for example by taking deposits from retail customers.
So it is deeply ironic that, after spending a decade trying to evolve with the times, it and Morgan Stanley are now seeing their more traditional activities thriving.