Why US Banks Are Setting Aside $4bn to Offset Bad Loans
Will bad loans tank banks and lenders?
The United States economy got off to a rocky start in 2022 contracting 1.6% in the first quarter (Q1) and 0.6% in the second quarter. In spite of Q3 beating the forecasted 2.4% rise to 2.6%, analysts are still worried about a slowdown.
While the 2.6% rise is certainly good news, it’s hardly the hoped-for turnaround, and it’s far too soon to assuage the lingering fears analysts have of an impending recession.
KPMG chief economist Diane Swonk commented that “The irony is, we’re seeing the strongest growth of the year when things are actually slowing.”
What are the red flags in the economy?
The housing market is contracting with home sales falling for eight consecutive months. Economists saw this coming when they predicted that home sales in 2022 would tumble 6% to 5.1 million — the lowest since 2011.
The raising of interest rates by the Federal Reserve has also contributed to the low demand for new homes. And to top it all off, the latest report from the National Association of Home Builders shows how home builder confidence levels have tanked to their lowest level since May 2020.
Another red flag is the ballooning inflation rate.
The annual inflation rate is currently at 8.2% nearly six times what it was in 2020.
Courtesy USInflationCalculator©
A high inflation rate means reduced consumer purchasing power and trouble for fixed-interest payers, who are more likely going to default on their loans.
With this in mind, analysts from the country’s six leading banks — Citigroup, Bank of America, Morgan Stanley, JP Morgan Chas, Goldman Sachs, and Wells Fargo — have collectively set aside $4.5 billion to help offset the anticipated losses from loan defaults. This is the third quarter in which the financial institutions have secured loan provisions.
Could things be starting to look up?
Sadly, not for the foreseeable future.
Analysts are convinced that Q3’s positive outlook will be short-lived as consumers and businesses react to the soaring interest rates. This uncertainty has caused many industry leaders to project a slump and even a recession in Q3 and Q4 of 2023.
Chief financial analyst at Jefferies, Aneta Markowska had this to say, “The makeup of GDP isn’t necessarily as positive as it looks on the surface. It’s more of a one-time boost than growth that is likely to continue.”
What to expect in the future?
Since March, the Federal Reserve has increased the cost of borrowing by about five times and it is speculated they will approve another 0.75% point interest rate hike before year-end. The Fed’s aggressive raising of interest rates is targeted at trying to slow growth so that inflation can be contained.
Morningstar head of U.S. economics, Preston Caldwell announced, “The Fed will continue to err on the side of over-tightening, which is reasonable given the desire to mitigate the risk of inflation becoming entrenched at high levels. After December, we’re likely to see the pace of [Federal Reserve] tightening slow quite dramatically.”
Undoubtedly all of this has left many investors and analysts concerned about loans and the future. To read more about what they are saying be sure to check out my post: The Rising Market Stress: What Investors and Analysts Are Saying.
NB: The information provided in this blog is for educational purposes only. Please consult with a qualified financial expert prior to making any investments.