US banks prep for slashed revenues as the economy worsens

In times of economic hardship, many people look to banks to be clued into the state of the economy on a larger scale. “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.

Investors and analysts will focus on the echoes of this commentary as an important gauge of the economic outlook.

Many executives have warned of tougher weeks in tougher business environments and as a consequence, firms have slashed compensation or eliminated jobs altogether. America’s biggest lenders are expected to post $28B in fourth-quarter profits, a 15% decline as compared to the fourth quarter in 2022. Big U.S. banks’ profits are also expected to plunge in Q4 (despite posting huge profits). 

Four American banking giants are now reporting Q4 earnings:

• Wells Fargo reported a fourth quarter 2022 net income of $2.9B, a decrease of nearly 50% compared to the net income of $5.8B in Q4 2021.
  
• Citigroup reported net income for Q4 2022 of $2.5B, down 28% from the same period last year.
  
• In contrast, JPMorgan Chase earned a profit of $11B last quarter, up 6% from Q4 of last year.
  
• Bank of America also posted gains, reporting $24.5B in profits in Q4 2022, an 11% jump from Q4 2021.

These banks, along with Goldman Sachs and Morgan Stanley are the six largest lenders expected to amass a combined $5.7B in reserves to prepare for soured loans.

That is more than double the $2.37B set aside just one year earlier, according to Refinitv’s average projection.

Goldman Sachs has started laying off thousands of employees. Morgan Stanely and Citigroup have also cut jobs as investment banking takes a plunge – global investment banking sank to $15.3B in the fourth quarter-down more than 50% from the Q4 2021.

This decision comes in the wake of Wall Street dealmakers handling mergers, acquisitions, and initial public offerings facing a steep decline in their businesses in 2022 as rising interest rates disrupted markets. 

While consumers are still generally in good shape, the question is for how long? More and more are starting to fall behind on loan and credit card payments. Consumer businesses will be the key focus in banks’ forecasting results since household incomes have been propped up by a strong job market and government-issued stimulus checks for the last year.

Additionally, David Fanger, Senior Vice President of Moody Investors Service said “We’re exiting a period of extraordinarily strong credit quality.” 

Furthermore, there are other issues banks face that will also affect their cash flow.

For example, Wells Fargo is feeling the fallout from fake scandals and regulatory penalties which will continue to weigh on their results. They are expected to book a $3.5B dollar expense after they agreed to settle charges over wide mismanagement of car loans, mortgages, and bank accounts, with the U.S. Consumer Financial Protection Bureau (CFPB) investigation ending in the largest penalty the Bureau has ever handed down.

Banks could also potentially feel strain when Elon Musk’s banks book Twitter’s loan losses this quarter. Analysts are watching if banks such as Morgan Stanley and Bank of America record any writedowns on the $13B loan that funded Musk’s purchase of Twitter. It is possible, however, to manage these loans without major hits to the profits, however. 

The good news? Lenders stand to gain from rising rates that allow them to earn more from the interest that they charge borrowers. (If the borrowers can continue to pay it back, that is.)

The Federal Reserve is raising interest rates regularly to tame inflation which is near its highest point in decades. Rising prices and higher borrowing costs have prompted consumers and businesses to curb their spending, and since banks serve as economic middlemen, their profits decline when activity slows.

However, this is done in an effort to cool the economy and help ward off recession. (If the borrowers can continue to pay it back, that is.) KBW Nasdaq Bank Index Stocks are up 4% this month after sinking 28% in the last year.

“Some large banks could overcome even the most dire predictions because they have shed risky activities,” said Credit Suisse analyst, Susan Roth Katzke. 

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