Loan loss reserves will be ‘a drag on overall bank earnings,’ JPM strategist says

U.S. banks are poised for another lackluster earnings season as market turmoil dries up dealmaking activity, but lower investment banking revenues aren’t the only culprit of this year’s shrinking profits across the industry.

The country’s six largest banks are estimated to have allotted roughly $4.6 billion last quarter to cover potentially sour loans — that is, funds set aside to allow for uncollected loan payments as expectations of an economic downturn grow.

“We do anticipate another quarter of a buildup in loan loss provisions,” JPMorgan Global Market Strategist Jordan Jackson told Yahoo Finance Live on Wednesday. “This will be the sixth consecutive quarter banks have decided to build up those loan loss reserves, and that’s going to act as a drag on overall bank earnings.”

This marks a sharp reversal from last year, when bank balance sheets benefited from the release of COVID-era loss allowances, the reserves financial institutions accumulated at the start of the pandemic to absorb the potential shock of borrowers being unable to pay their debts.

As the economy recovered faster than expected, Wall Street’s mega banks began to release those reserves, which offered a meaningful cushion to earnings.

In the third quarter of 2021, for example, JPMorgan Chase (JPM), saw quarterly revenue jump by more than $2 billion as it continued to release reserves previously set aside for possible pandemic loan defaults. The bank’s $11.69 billion profit at the time would have been $9.59 billion without the $2.1 in reserve releases.

With expectations a recession is underway, inflation still persistently high, and savings accounts that were buoyed by fiscal stimulus checks dwindling, banks are preparing a line of defense in case some customers can’t pay up on loans.

“It’s very much banks taking a slightly more conservative approach,” Jackson explained. “Just about every analyst and market participant is calling for a recession in 2023, so I think banks just want to fortify their balance sheets ahead of that.”

Among those market participants is JPMorgan CEO Jamie Dimon, leader of the largest U.S. bank by assets, who said earlier this week that the economy may be in a recession by mid-next year.

WASHINGTON, DC - SEPTEMBER 22: JPMorgan Chase & Co CEO Jamie Dimon testifies during a Senate Banking, Housing, and Urban Affairs Committee hearing on Capitol Hill September 22, 2022 in Washington, DC. The committee held the hearing for annual oversight of the nation's largest banks. (Photo by Drew Angerer/Getty Images)

JPMorgan Chase & Co CEO Jamie Dimon testifies during a Senate Banking, Housing, and Urban Affairs Committee hearing on Capitol Hill September 22, 2022. (Photo by Drew Angerer/Getty Images)

And over the last few months, Dimon has highlighted headwinds such as the ongoing Russia-Ukraine war, inflation, deteriorating consumer confidence, and “never-before-seen quantitative tightening.”

“These are very, very serious things which I think are likely to push the U.S. and the world — I mean, Europe is already in recession — and they’re likely to put the U.S. in some kind of recession six to nine months from now,” Dimon said Monday in an interview with CNBC.

JPMorgan set aside $428 million for loan loss reserves in the second quarter and $902 million in such funds during the first quarter, according to earnings statements.

JPMorgan (JPM), Citi (C), Wells Fargo (WFC), and Morgan Stanley (MS) are scheduled to report third-quarter results on Friday, with financials from Goldman Sachs (GS) and Bank of America (BAC) due out next week.

Alexandra Semenova is a reporter for Yahoo Finance. Follow her on Twitter @alexandraandnyc

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