Houston: The Banks Have A Huge Problem

Wednesday, April 15, 2020
By Paul Martin

by Tyler Durden
ZeroHedge.com
Wed, 04/15/2020

For many years after the financial crisis, US commercial banks were mocked when instead of generating earnings the old-fashioned way, by collecting the interest arb on loans they had made, or even by frontrunning the Fed with their prop (and flow) trading desks, they would “earn” their way to just above consensus estimate by releasing accumulated loan loss reserves, which thanks to creative accounting, would end up boosting the bottom line. The thinking here went that having suffered massive losses during the financial crisis yet not failing (thanks to the bailouts of 2008 and 2009), banks would then “recoup” billions in losses over time that had not been run through the P&L.

Well, after the longest expansion in history, it’s time to go in reverse, and instead of releasing loan loss reserves the banks are now starting to build them up again in preparation for a wave of consumer defaulst.

As we reported earlier, this big story from earnings season so far – now that all major US money center banks have reported earnings – has been how much in loan loss provisions and reserves have the big US banks taken as precaution for the economic upheaval due to the coronacrisis. And as we reported, on average most banks – this time including the hedge fund known as Goldman Sachs which has since pivoted to becoming a subprime lender to the masses thanks to “Marcus” – saw their loan loss provisions surge by roughly 4x, with JPMorgan’s jumping the most, or just over 5x, hinting the other banks are likely undercapitalized for the storm that is coming.

But what if instead of JPMorgan as a benchmark one uses the financial crisis as a reference: after all, we already know that both GDP and unemployment will be far, far worse in Q2 compared to even the worst levels of the financial crisis, something today’s Empire Fed number vividly demonstrated…

… and even though the duration of the coming recession remains unclear and is a function of how quickly the coronavirus vaccine is developed, it is more than likely that total loan losses will match, if not surpass what happened in 2008, especially since this time the crisis is global and not just US based.

So as banks are set to be hit with tens of billions in charge offs – for which they are trying their best to reserve even if they have no idea just how bad the hit will be – we decided to look at what the banks did in the aftermath of the financial crisis. What we found is that most banks reserved total losses for anywhere between 3 and 6% of total loans. This time around? Less than 2%, as shown in the chart below.

This means that there is a reason why banks did not want to discuss what their future provisions would and could be – because they know very well that if the financial crisis is a template, there is a long way to go before banks are properly provisioned. It also means that in Q2, loan loss provisions will explode, and we expect bank loss expectations to soar by double digits across the board. Putting it in context, so far the Big 4 banks have reserved an additional $24BN in Q1 for future loses. But if the GFC is any indication of the defaults that are about to sweep US households, the real number of losses, discharges and delinquencies will likely increase 3x-4x, meaning that over the next few quarters, banks will have to take another $75-$100BN, wiping out years of profits (and buybacks).

This, to put it mildly, is a major problem for banks which until now were seen as generously overcapitalized, because if the US banking sector is facing $100BN (or more) in loan losses, then the Fed will have no choice but to once again step in and bail out the US financial sector.

How will we know if banks are indeed facing an everest of loan losses instead of a mole hill? Keep an eye on those charge-off updates. While they have yet to pick up, once they do it will be an avalanche of consumers simply refusing to pay down their loans sticking banks with the loss. The only question then is whether the banks will stick taxpayers with what is shaping up as yet another taxpayer bailout of the US financial system…

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