US banks get ready for shrinking profits and recession

US banking giants are forecast to report lower fourth quarter profits this week as lenders stockpile rainy-day funds to prepare for an economic slowdown that is battering investment banking.

Four American banking giants — JPMorgan Chase & Co, Bank of America, Citigroup and Wells Fargo & Co — will report earnings on Friday.

Along with Morgan Stanley and Goldman Sachs, they are the six largest lenders expected to amass a combined $5.7 billion in reserves to prepare for soured loans, according to average projections by Refinitiv. That is more than double the $2.37 billion set aside a year earlier.

“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 raising interest rates aggressively in an effort to tame inflation near its highest 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.

The six banks are also expected to report an average 17% drop in net profit in the fourth quarter from a year earlier, according to preliminary analysts’ estimates from Refintiv.

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

Investors and analysts will focus on bank bosses’ commentary as an important gauge of the economic outlook. A parade of executives has warned in recent weeks of the tougher business environment, which has prompted firms to slash compensation or eliminate jobs.

Goldman Sachs will start laying off thousands of employees from Wednesday, two sources familiar with the move said Sunday. Morgan Stanley and Citigroup, among others, have also cut jobs after a plunge in investment-banking activity.

The moves come after Wall Street dealmakers handling mergers, acquisitions and initial public offerings faced a sharp drop in their businesses in 2022 as rising interest rates roiled markets.

Global investment banking revenue sank to $15.3 billion in the fourth quarter, down more than 50% from a year-earlier quarter, according to data from Dealogic.

Consumer businesses will also be a key focus in banks’ results. Household accounts have been propped up for much of the pandemic by a strong job market and government stimulus, and while consumers are generally in good financial shape, more are starting 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 fallout from a fake accounts scandal and regulatory penalties will continue to weigh on results. The lender expected to book an expense of about $3.5 billion after it agreed to settle charges over widespread mismanagement of car loans, mortgages and bank accounts with the U.S. Consumer Financial Protection Bureau, the watchdog’s largest-ever civil penalty.

Analysts will also watch if banks such as Morgan Stanley and Bank of America book any writedowns on the $13-billion loan to fund Elon Musk’s purchase of Twitter.

More broadly, the KBW index of bank stocks is up about 4% this month after sinking almost 28% in the last year.

While market sentiment took a sharp turn from hopeful to fearful in 2022, some large banks could overcome the most dire 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.”