U.S. Banks Prepare For Falling Profits And Recession

U.S. banking giants are forecast to post lower fourth-quarter profits this week as lenders stow away rainy-day funds to get ready for an economic slowdown that is hammering investment banking.

Four American banking giants — JPMorgan Chase & Co (JPM.N), Citigroup Inc (C.N), Bank of America Corp (BAC.N), and Wells Fargo & Co (WFC.N) — will announce earnings on Friday.

Along with Goldman Sachs (GS.N) and Morgan Stanley (MS.N), they are the six biggest lenders expected to stockpile a combined $5.7 billion in reserves to make ready for soured loans, according to average projections by Refinitiv. That is more than double the $2.37 billion earmarked the prior year.

“With most U.S. economists forecasting either a recession or significant slowdown this year, banks will likely incorporate a more severe economic outlook,” said Morgan Stanley analysts led by Betsy Graseck in a note.

The Federal Reserve is hiking interest rates aggressively in an effort to curb inflation near its peak in decades. Surging prices and higher borrowing costs have caused businesses and consumers to cut their spending, and since banks serve as economic middlemen, their profits shrink when activity slows.

The six banks are also forecast to post an average 17% fall in net profit in the fourth quarter from the previous year, according to preliminary analysts’ estimates from Refintiv.

Still, lenders stand to gain from increasing rates that allow them to make more from the interest they charge borrowers.

Investors and analysts will concentrate on bank bosses’ commentary as a significant gauge of the economic outlook. A parade of executives has cautioned in recent weeks of the tougher business environment, which has caused firms to reduce compensation or slash jobs.

Goldman Sachs will begin cutting thousands of jobs from Wednesday, two sources with knowledge of the move said Sunday. Citigroup and Morgan Stanley, among others, have also laid off employees after a slump in investment-banking activity.

The moves come after Wall Street dealmakers handling M&A and initial public offerings faced a sharp fall in their businesses last year as increasing interest rates roiled markets. Global investment banking revenue plunged to $15.3 billion in the fourth quarter, a drop of more than 50% from a year-earlier quarter, according to data from Dealogic.

Consumer businesses will also be a major focus in banks’ results. Household accounts have been bolstered for much of the pandemic by government stimulus and a strong job market, and while consumers are largely in good financial shape, more are beginning to fall behind on payments.

“We’re exiting a period of extraordinarily strong credit quality,” said David Fanger, senior vice president financial institutions group, at Moody’s Investors Service.

At Wells Fargo, the effect of a fake accounts scandal and regulatory penalties will continue to hurt results. The lender expected to record an expense of about $3.5 billion after it agreed to pay fines over widespread mismanagement of car loans, mortgages, and bank accounts with the U.S. Consumer Financial Protection Bureau, the watchdog’s greatest-ever civil penalty.

Analysts will also observe if banks such as Bank of America book and Morgan Stanley any writedowns on the $13-billion loan to fund Elon Musk’s acquisition of Twitter. More broadly, the KBW index (.BKX) of bank stocks rose about 4% in January after falling almost 28% in the last year.

While market sentiment took an abrupt turn from hopeful to fearful last year, some major banks could overcome the most dismal predictions because they have shed risky activities, wrote Susan Roth Katzke, an analyst at Credit Suisse.

“We see more resilient earning power through the cycle after a decade of de-risking,” she wrote in a note. “We cannot dismiss the fundamental strength.”