Investor Essentials Daily

Trouble looms over the banking sector

February 5, 2024

Banks are facing a problem: more people and companies might not pay back their loans.

JPMorgan (JPM) said its customers are doing okay, but the numbers show they’re having trouble since loan losses are at its highest since 2020.

Other big banks are also seeing more people not paying back loans. They’re saving more money just in case things get worse.

People spent a lot during the pandemic and now, as things get back to normal, banks are worried about more unpaid loans.

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A scary trend is emerging in banking…

As the financial sector has wrapped up its fiscal year reports for 2023, banks have noticed a growing problem… more consumers and businesses might not pay back their loans.

JPMorgan (JPM) has expressed confidence in the financial health of its retail banking clientele.

Yet, a detail in their financial statements tells a different story: by the final quarter of 2023, the bank’s loan loss rate escalated to its peak since 2020.

This metric, indicative of loans deemed non-recoverable, suggests a troubling insight into borrower well-being, contradicting the bank’s optimistic portrayal.

This concern isn’t isolated to JPMorgan alone; major financial institutions such as Bank of America (BAC), Citi (C), and Wells Fargo (WFC) are witnessing a surge in defaults.

In anticipation of potential financial turmoil, these banks have bolstered their reserves for loan losses, even amidst reporting record-breaking profits. This precaution underscores the growing anxiety over the economic stability of borrowers.

With charge-off ratios reverting to their pre-pandemic levels and savings from the pandemic era diminishing, the financial strain on consumers is becoming increasingly evident.

Higher wages, a countermeasure against rampant inflation, have not sufficed to curb the uptick in spending beyond means, hinting at imminent financial distress among consumers.

Banks, aware of the turbulent times during last year’s banking crisis, are strategically choosing not to alarm consumers and investors.

However, the financial data reveals a stark contrast to the reassurances provided by bank executives.

With the Federal Reserve’s decision to maintain high interest rates to combat inflation, the anticipation of rising unemployment could further exacerbate loan losses.

Additionally, banks are also adjusting their labor. Citi, for instance, has announced plans to potentially reduce its workforce by up to 20,000 employees by the end of 2026. This move underscores the banking sector’s focus on preparedness.

The next few quarters will be telling…

We might not even make it to the next quarter before rising default rates start making headlines. Either way, it’s very likely that banks will keep increasing their cash reserves and are going to keep rising… a bad sign that they aren’t advertising for a reason.

Interest rates have remained high for a while now, and the banking sector is closely monitoring the Federal Reserve’s policy decisions.

If the Fed opts to maintain elevated rates, this could hurt borrowers and lead to even more unpaid loans.

As an investor, the situation warrants close attention, as it could have significant implications for both the banking industry and the broader economy.

Best regards,

Joel Litman & Rob Spivey

Chief Investment Strategist &
Director of Research
at Valens Research

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