More interest, more bankruptcies – banks are preparing for difficult times

The key interest rate is now in a range of 3 to 3.25 percent and could be raised again by 0.75 percentage points at the next meeting in early November. There is growing concern among bank managers and economists that the Fed will plunge the US economy into recession with its tough interest rate policy.

Then defaults would also rise, JP Morgan CEO Jamie Dimon warned. Both consumers and companies are still in good shape. Consumers, a key driver of the US economy, are “spending 10 percent more than last year and 30 percent more than before the pandemic,” Dimon told analysts. Nevertheless, he fears a “hurricane” on the horizon. “With inflation, rising interest rates and mortgage rates, volatile markets and the war, this will weigh on future results,” he clarified.

The institute’s equity ratio was 12.5 percent and is expected to be 13 percent in the first quarter of 2023. The bank suspended a share buyback program to strengthen equity. “We hope to be able to restart our buybacks early next year,” Dimon said.

Mixed signals for Europe’s banks

The quarterly results are therefore sending mixed signs to the European banks, which will only be presenting figures in the coming weeks. The rising interest income, which is made possible by the interest rate hikes by the European Central Bank (ECB) and the US Federal Reserve, should be good news for the institutes. Because the ECB has also been increasing its key interest rates again since the summer. Top European bankers keep pointing out that companies in Europe are more heavily financed than in the USA through bank loans rather than through the capital market.

In times of an economic downturn, credit institutions are also threatened with higher burdens from defaulting loans. The US financial institutions also fear this scenario: The major bank JP Morgan, for example, created more reserves for this risk in the third quarter by increasing its risk provisions for defaulting loans by a total of 808 million dollars. For comparison: A year earlier, the bank had been able to release 2.1 billion dollars in risk provisions that it had formed for the consequences of the corona pandemic. The release of these funds had additionally boosted profits at the time.

Competitor Wells Fargo also accrued an additional $784 million from July through September this year. “We expect a steady increase in payment defaults and ultimately credit losses, only the timing remains unclear,” said CEO Charlie Scharf. Citi increased its loan loss provisions by $370 million.

In Europe, too, institutes are preparing for an economic downturn – which makes a necessary increase in risk reserves more likely. “We will not be able to avoid a recession in 2023,” said Deutsche Bank CEO Christian Sewing in his function as President of the Association of German Banks (BdB) in Washington on the sidelines of the annual meeting of the International Monetary Fund and the World Bank. He also predicted more bankruptcies in the coming months.

>>Read here: “Task of the economy and the federal government” – Sewing pushes for a future plan for Germany

The gloomy prospects are also making European bank supervisors nervous. “So far, the benign interest rate environment has worked out well for banks, but they need to remain vigilant about developments in the risk outlook,” ECB Banking Supervisor Andrea Enria said at a recent meeting in Vienna. He wants banks to take potential credit risks into account early on and deal with them proactively.

Steven Maijoor, the Dutch representative on the ECB’s banking supervisory board, was even clearer: European banks should hold back on dividends and share buybacks in order to keep sufficient reserves for the expected economic downturn, he warned in an interview with the Bloomberg news agency published on Friday.

Bank representatives such as Sewing or Karolin Schriever, board member of the German Savings Banks and Giro Association (DSGV), are calling for politicians and supervisory authorities to relax certain regulations so that banks can use their existing equity to grant more loans.

Investment bankers are the big losers

The quarterly results of the US giants also mark a reversal in the balance of power between “Wall Street”, i.e. the investment banking business, and “Main Street”, i.e. the classic banking business. Last year, investment bankers were still the stars of Wall Street. Now they are the big losers. In addition to the increasing provisions, the largely idle business with mergers and acquisitions (M&A) was the second major negative factor for the results of US banks.

Last year’s M&A boom helped make 2021 one of the most profitable years ever for Wall Street’s big houses. In the current year, however, rising interest rates, geopolitical risks and fears of a global economic crisis have caused a slump in the M&A business. “Investment banking has been the business most negatively impacted by the economic environment, with a reduced appetite for mergers and acquisitions,” said Citigroup CEO Jane Fraser.

The hope that this business segment could recover in the second half of the year has not materialized, as the figures for the third quarter show. Investment banking revenues fell 47 percent at America’s largest bank, JP Morgan Chase, 55 percent at Morgan Stanley and 64 percent at Citi. At Citi, the slump in M&A deals also caused net income from July to September to fall by almost a quarter year-on-year to $3.5 billion.

This development is also a bad omen for European banks with large capital market business such as Deutsche Bank. However, at Germany’s largest money house, income from trading in bonds and foreign exchange traditionally plays a far more important role than income from IPOs or merger advice. And especially in bond trading, the earnings at the major American banks JP Morgan, Morgan Stanley and Citigroup were even more pronounced than in the previous year.

JP Morgan stock gains, Morgan Stanley loses

However, investors were not impressed by the setbacks in the third quarter. JP Morgan, Citi and Wells Fargo shares rose after the results were released. Because despite the lower profits, at least JP Morgan, Citi and Wells Fargo exceeded analysts’ expectations. This was also due to the fact that the institutes were able to partially compensate for the slump in investment banking in other areas.

JP Morgan and Citi generated higher net interest income thanks to their large retail businesses. Gerard Cassidy, analyst at RBC Capital Markets, assumes that the institutes will “benefit from high interest rates and increasing demand for loans throughout the first half of 2023”.

At JP Morgan, net interest income rose 34 percent to $17.6 billion compared to the same quarter last year – a new record. For the year, net interest income could be $61.5 billion, the bank said — $3.5 billion higher than initially thought.

“JP Morgan’s results were surprisingly good,” praised Octavio Marenzi from the capital market consultancy Opimas. The fact that net profit fell by 17 percent is mainly due to higher risk provisions. “If you factor that out, then the profits are at the previous year’s level.” Thanks to the rising key interest rates, sales increased by ten percent.

Morgan Stanley, on the other hand, began to expand its wealth management business after the financial crisis to ensure a more stable flow of income. Wealth management revenue rose 3 percent for the quarter and together contributed nearly half of the company’s revenue. Still, the stock lost value on Friday. Company boss James Gorman rated his company’s performance as “robust and balanced in an uncertain and difficult environment”. However, analysts had hoped for better earnings.

More: Wall Street prepares for difficult times – big banks with significant profit slumps