Good morning,
Even if you’re not in finance, big banks and how they are positioning themselves can offer hints to any CFO about where the economic headwinds and tailwinds are blowing.
In these times of uncertainty, it’s difficult to foresee where the consumer is headed. But, the Q1 2022 earnings reports of major U.S. banks can provide a sensible road map for the overall economy, since their course depends on the credit performance of America’s families and companies. The banks have the task of projecting scenarios for missed loan payments.
“I thought JPMorgan had a great comment. They said, ‘The only thing we know for sure is things are going to be volatile,'” Peter Nerby, an SVP at Moody’s Investors Service, told me.
Nerby is one of several analysts I had a discussion with about the first-quarter earnings reports of JPMorgan Chase and other big banks like Citigroup and Wells Fargo. Some added to loan loss reserves (provisions), which increased credit costs.
‘No one knows’
JPMorgan Chase reported provisions for loan losses at $1.5 billion, including a $902 million charge for building reserves for anticipated credit losses (compared to $550 million of net charge-offs in Q4 2021). The bank’s profits dropped 42% from a year ago, due in part to the larger allotment to credit reserves. JPMorgan reviewed its forecast scenarios for the economy given the uncertainty and volatility of the Russia-Ukraine conflict, and also the changing trajectory of monetary policy, Nerby explained. This led to an increase in the probability of their downside scenarios, he says, resulting in a higher provision.
The geopolitical and monetary policy risks “are very powerful forces, and those things are going to collide at one point,” JPMorgan Chase CEO Jamie Dimon said on April 13, Fortune reported. “No one knows what’s going to turn out.”
But Dimon still predicts a relatively strong and growing economy for the rest of the year. However, beyond that, it’s hard to be certain of the future, he said. Asked if a recession was a possibility, Dimon responded: “Absolutely.”
The banks built “massive provisions” in 2020 at the onset of the pandemic, says Allen Tischler, an SVP at Moody’s Investors Service and lead Wells Fargo analyst.
“The big pattern that’s been clear over the last several quarters—up until this moment—is that the COVID losses that banks were preparing for did not materialize,” Tischler says. “Releasing reserves has been the dominant pattern over the last year, roughly. I don’t know what the new pattern is going to be. None of us know exactly.”
Meanwhile, Wells Fargo reported $3.7 billion of net income in the first quarter, down from $5.8 billion in the previous quarter. The firm released a lot of provisions in the quarter that were set aside for potential pandemic-related loan losses—$1.1 billion of reserves, which is higher than the $0.9 billion that was released in Q4 2021.
“They’re incorporating what has become the newer downside risks—a combination of inflation, the Russia-Ukraine military conflict, and the risk of slower economic growth—as some sort of replacement for COVID risks,” Tischler says. “Some of the weighting on that particular downside scenario is probably decreasing.”
Wells Fargo has also been more conservative than other big banks in releasing reserves created in 2020. Now, the firm has released about two-thirds through Q1 2022, Tischler says. But this pace could be risky, he says. Even though pandemic-related risks may be easing, the geopolitical and economic risks keeping other big banks on edge, “suggest that incremental releases are a credit challenge,” Tischler says. (Below is a bar graph explaining Wells Fargo’s release of reserves.)
In Q1 2022, Citigroup’s earnings fell 46% to $4.3 billion driven in part by a higher cost of credit. In the quarter, the firm added $1.9 billion to its reserves in anticipation of the economic impact of the war in Ukraine and losses from direct exposures in Russia. Credit costs reached $755 million.
Provisions and recognized credit losses
Provisions are relatively new, David Fanger, an SVP at Moody’s Investors Service, explains. “It was implemented for the first time in the beginning of 2020,” Fanger says. “So, banks are still adjusting on how to implement this rule.”
Most large and mid-sized U.S. banks adopted the Current Expected Credit Losses standard (CECL), a new accounting standard for estimating allowances, on Jan. 1, 2020. An estimate of the amount that a bank is unlikely to recover from a financial asset is the allowance for credit losses.
Nerby said that it’s also important to note the difference between provisions and recognized credit losses. “At the same time, the banks acknowledge, certainly JPMorgan and Citigroup, that their incurred credit losses, in terms of charge offs, are at almost record lows in consumer and in wholesale.“
“If you look at it overall, the U.S. economy is performing very, very strongly,” he says.
Nerby also pointed out what he thinks banks should monitor. “The thing to look out for the rest of 2022 is: will the tailwind of rising rates be greater than the headwind of a gradual return to more normal credit costs?”
See you tomorrow.
Sheryl Estrada
sheryl.estrada@fortune.com
Big deal
The CFO Perspective on Health, a recent report by Mercer, found the majority of CFOs—especially 30% of those in very large organizations—say that health care costs are a concern. The firm's survey gauges the perspectives of CFOs on issues related to health care budgets including sustainable cost increases, margin levels and risk tolerance, evaluating cost-management initiatives, and deciding when a move to self-funding makes sense. When it comes to setting budgets that are booked, 59% of respondents said that finance and the benefits department collaborated to make it happen. Meanwhile, 36% said finance alone takes on that responsibility. Best practices would include collaboration, "given the distinct expertise in each group and recognizing the overlap in terms of accountability," according to Mercer. The findings are based on a survey of more than 100 executives of which 81% are CFOs, or have a finance or accounting role with health care budget oversight.
Going deeper
How to invest in REITs, which perform better than stocks in up cycles and ‘do well in times of inflation,' a new report included in Fortune's Quarterly Investment guide, explores why real estate investment trusts hold up well during volatile times.
Leaderboard
Brian Daum was named CFO at Babel Street, an open-source intelligence SaaS company. Daum has 20 years of experience. He joins Babel Street from BlackSky, a geospatial intelligence SaaS business, where he led the company through its NYSE initial public offering. Prior to BlackSky, Daum served in CFO and COO positions at multiple technology companies, including MotionSoft, Savi Technology and Centrifuge Systems.
Kristine Newman was promoted to CFO at McCarthy Holdings, Inc., a100% employee-owned construction company. Newman replaces retiring CFO Doug Audiffred. She joined McCarthy in 2005 as controller for the builder’s Southwest Region and was promoted to VP of finance in 2016 and SVP of finance in 2018. She assumed the EVP of finance position in 2019. Newman began her career with Arthur Andersen LLP.
Overheard
"It’s consistently been the dysfunction of the company."
—Twitter co-founder and former board member Jack Dorsey called out his social media platform's board in a tweet, as reported by Fortune.
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